What Is A Home Equity Line Of Credit?

Key Takeaways 

• A HELOC is a type of loan where you borrow against the equity in your home, using the property as collateral. 
• With a HELOC, you don’t get a lump sum upfront. Instead, you receive access to a line of credit. You can borrow as much as you need when you need it and only repay the amount you borrow, plus interest. 
• You can typically borrow up to 80-85% of the property’s appraised value, minus what you owe on your current mortgage. 
• A HELOC can be a good option if you don’t need a large sum upfront, if you don’t know how much you’ll need to borrow or don’t know when you’ll need it. 
• The biggest risk with taking out a HELOC is the possibility of foreclosure and losing your home if you’re unable to make the payments. 

 Are you thinking of applying for a home equity line of credit (HELOC)? 

This guide covers everything you need to know about a HELOC: how it works, how to qualify, how much you can borrow, how much it costs, and the risks involved.   

What is a HELOC? 

A home equity line of credit or HELOC is a type of loan where you borrow against the equity you have built in your home, using the property as collateral. 
 
Unlike other loans, such as home equity or personal loans, you don’t get a lump sum upfront. Instead, you get access to a rolling line of credit that works much like a credit card. You can borrow as much as you need when you need it if you don’t exceed the limit. Then, you make payments only on the amount you borrowed, plus interest. 

Who qualifies for a HELOC? 

Eligibility criteria vary across providers, but in most cases, you will need: 

• At least 15-20% equity in your home 
• A minimum credit score of 620 
• A debt-to-income (DTI) ratio of 43% or lower 

To determine how much you can borrow with a HELOC, multiply the market value of your home by 80% (or 85%). Then subtract the amount you owe on your current mortgage, if any. 

For example, if your home’s market value is $500,000, 85% of that amount is $425,000. 

If you owe $400,000 on your mortgage, the maximum you can borrow would be $425,000 minus $400,000, or $25,000 (assuming you have no other liens on the property). 

This is only a rough calculation. Lenders will consider other factors, too, such as your credit history and other unpaid debts, to determine your credit limit. 

Unlike other loans, such as home equity loans or personal loans, you don’t get a lump sum upfront. Instead, you get access to a rolling line of credit that works much like a credit card. You can borrow as much as you need when you need it, as long as you don’t exceed the limit. Then, you make payments only on the amount you borrowed, plus interest. 

How can you spend money from a HELOC? 

You may use a HELOC to pay for anything you’d like, from home improvements to education expenses. To access the funds, you would use a card or check connected to the account. If necessary, you can withdraw money weekly or even daily. Be sure to ask the lender if there are minimum or maximum withdrawal limits. 

What is the loan term? 

HELOC terms vary across lenders but can typically run for up to 30 years. This often includes an initial 10-year draw period, during which you can access the funds, and up to 20 years to repay. 

How do you repay a home equity line of credit? 

At the end of the draw period, the lender may renew your credit line. If not, the repayment period kicks in, and your outstanding balance, plus interest, becomes due. 

Depending on the loan agreement, you repay the loan over time or all at once. You may need to pay back the principal and interest over time, or interest only. If you’re paying interest only, the principal becomes due at the end of the loan term, when you have to make a large balloon payment. It’s important to understand your HELOC’s terms up front. If you need to make a balloon payment, you’ll need to save up for that throughout the HELOC’s term. 

If, however, you can’t afford the balloon payment when it becomes due, you can try to renegotiate the repayment terms. Some lenders may refinance the outstanding balance or extend the repayment period. 

What Are the Interest Rates? 

Most HELOCs have variable interest rates. That means the rate can change over the term of the loan – even as often as month to month. Lenders often offer a discounted rate for the first few months, or even longer, but the rate (and payments) may rise afterward. 

Before committing, check if there are any rate caps. A periodic cap limits how much the rate can change at one time. A lifetime cap limits how much the rate can change throughout the loan term. 

It’s also a good idea to check the index and the margin. Lenders use an index, such as the prime rate, to decide how much to raise or lower interest rates. The margin is an amount that lenders add to the index to determine the interest rate. Ask your provider what the margin is, which index they use, and how often and how much it can change. 

You can ask the lender if you can switch from a variable to a fixed rate later in the loan term. Some HELOC lenders offer this option to borrowers during the draw period. 

Fixed Rates 

Some lenders offer fixed-rate HELOCs. The interest rate may be higher than the initial rate on a variable-rate HELOC, but the payments will stay the same over the entire term of the loan. 

How much does it cost to take out a HELOC? 

If you’re considering a home equity line of credit, be prepared to pay at least several hundred dollars in upfront costs. These may include: 

• Application fees
• Title search fees 
• Home appraisal fees 
• Processing and underwriting fees 
• Points and other upfront charges 
• Attorney fees
• Minimum withdrawal requirement when you open the account 

In addition to the initial costs, you may also incur continuing expenses throughout the loan term. Some lenders require participation or annual membership fees, which are payable even if you don’t use the account. You may also need to pay a transaction fee each time you borrow money. 

What Happens if You Miss a Payment? 

The biggest risk with HELOCs is losing your home if you can’t make your payments. (Remember your home serves as collateral.) Because the foreclosure process can be costly, lengthy and complicated for both borrowers and lenders, providers generally won’t automatically foreclose. 

Instead, they will likely freeze or reduce your credit line first. During the application process, make sure to ask the lender about late-payment penalties, and under what conditions they will consider you in default and request immediate full payment. 

The more equity you have in your home, the more likely a lender would be to initiate foreclosure. That is because the lender has a greater chance of recovering some of the money after you pay off your mortgage and any other debts. 

If you’re “underwater” – meaning your home is worth less than what you owe on it – foreclosure is less likely. Pre-existing mortgages take precedence, so the HELOC provider won’t receive much, or anything at all, after a foreclosure. 

Instead, the lender may sue you for the amount you owe, which can significantly hurt your credit score. The lender may also levy bank accounts, garnish wages or repossess other property. 

Can you get out of a HELOC agreement? 

Under federal law, you have three days to reconsider a signed HELOC and cancel it without penalty for any reason. 

You can cancel the transaction until midnight of the third business day. Business days include Saturdays but not Sundays or public holidays. 

Day one begins after you: 

• Sign the contract 
• Receive a Truth-in-Lending disclosure form 

• Get two copies of a Truth-in-Lending notice 

You must inform the lender in writing, after which it has 20 days to return all the fees you paid and release any security interest in your property. 

The three-day cancellation rule only applies if the property is your principal residence, not a vacation or second home. 

Are there any legal safeguards to protect borrowers? 

The federal Truth in Lending Act protects borrowers from unfair lending practices. It requires lenders to tell you about the APR, payment terms, and any initial and continuing charges when you apply for a loan. This protects you from changes in the terms (other than fluctuations in the variable rate) before you open your account. 

Once you open a HELOC, the lender may not terminate the plan, accelerate repayments, or change the loan terms if you pay as agreed. 

Read the closing papers carefully before signing. Ask questions or see if you can negotiate changes.  

Is a home equity line of credit right for you? 

A HELOC loan can be a good option if you don’t need a large sum upfront, if you don’t know how much you’ll need to borrow or when you’ll need it. 

HELOCs may also have tax advantages. To learn more, talk to a tax adviser or an accountant about your situation. 

Debt-based products 

If you need a lump sum upfront, you may want to investigate other types of loans, such as: 

• Personal loans 
• Home equity loans 
• Second mortgages 
• Reverse mortgages 

Equity-Based Products 

What if you need a lump sum upfront but don’t meet the criteria for most debt-based products? If you have a lower income, less-than-stellar credit history or just do not want another monthly debt payment, taking out a traditional loan may not be an option for you. 

In that case, consider an equity-based product such as Unlock Technologies’ home equity agreement (HEA). An HEA is not a loan, so there are no income requirements, monthly payments or interest charges. 

How HEAs work 

With an HEA, you receive a lump sum of cash upfront (typically up to 10% of your home’s current market value) in exchange for a share of the equity in your home. You can use the cash received to eliminate existing debt, invest in home improvements, build a cash cushion, pay for your children’s education or a range of other options. 

By the end of the 10-year term, you must buy back your equity. This often occurs when you sell your home. At that time, the HEA provider receives a share of the proceeds.  

In the meantime, you get to live in the property and enjoy all benefits of ownership. That also means you’re responsible for paying property tax, homeowners’ insurance and any ongoing maintenance costs. 

Looking for alternatives to HELOCs? 

HELOCs and other debt-based products are not for everyone. Fortunately, there’s more than one way to tap into your home equity. 

At Unlock Technologies, we help you leverage your home equity without taking out a loan, giving you greater flexibility and control over your finances. 

You’ve spent years building equity in your home. It’s time to unlock it and have it work for you.