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 85% of the property’s appraised value, less what you owe on your current mortgage.
A HELOC can be a good option if you don’t need a large sum upfront, know how much you’ll need to borrow or when you’ll need it.
The biggest risk if you default on a HELOC is losing your home.
Are you thinking of applying for a home equity line of credit (HELOC)?
If so, this guide is for you. It covers everything you need to know: what a HELOC is, who qualifies, how much you can borrow, what the interest rates are like, what to watch out for and more.
Knowing how HELOCs work is critical to making an educated decision on whether to consider one. If you do get a HELOC and things go wrong, and you can’t keep up with the payments, you risk losing more than just money. Because your property serves as collateral, your home is on the line, too.
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, as long as you don’t exceed the limit. Then, you make payments only on the amount you borrowed, plus interest.
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
You can typically borrow up to 85% of your home’s appraised value, minus the amount you owe on your current mortgage, if any.
For example, let’s assume your home’s appraised value is $500,000, so 85% of that amount is $425,000.
If you owe $400,000 on your mortgage, the maximum you can borrow is $425,000 less $400,000, which equals $25,000 (assuming you have no other liens on the property).
This is only a rough calculation. In reality, lenders will consider multiple other factors, too, such as your credit history or unpaid debts, to determine your credit limit.
You may use a HELOC to pay for anything you’d like, from small day-to-day expenses to large life purchases. 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.
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 a 20-year repayment period.
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.
If you can’t afford the balloon payment, you can try to renegotiate the repayment terms. Consider asking the lender to refinance the outstanding balance or extend the repayment period.
Unlike home equity loans, the annual percentage rate (APR) – the yearly interest on the loan – for HELOCs doesn’t take points and financing charges into account. The stated APR includes only interest.
Most HELOCs have variable interest rates. Lenders often offer a discounted rate for the first few months, but the rate (and payments) may go up afterward.
If you’re considering a variable rate, make sure that you understand the terms of the agreement and shop around before committing to a lender.
You should also check if there’s a periodic cap, which limits how much the rate can change at one time, or a lifetime cap, which 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 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.
Last but not least, don’t forget to ask whether you can switch from a variable to a fixed rate later in the loan term.
At first, fixed interest rates may be higher than variable rates. But the payments will stay the same over time.
If you’re thinking of getting a home equity line of credit, be prepared to pay at least several hundred dollars in upfront costs. These may include:
Title search fees
Home appraisal fees
Mortgage preparation and filing
Points and other upfront charges
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 whether or not you use the account. On top of that, you may also need to pay a transaction fee each time you borrow money.
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 it 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.
Expenses like these can add substantially to the cost of your HELOC, especially if you end up borrowing little from your credit line. To get the best deal, shop around and negotiate with multiple lenders. Some might agree to cover some of the expenses.
With variable interest rates, changes in the market can affect payments over the life of the loan. Unexpected financial events might leave you unable to pay the loan back even if you thought you could when you signed the paperwork. In some cases, lenders may also pause credit advances on your account if current interest rates exceed your maximum rate cap.
Lenders mitigate such risks by limiting how much you can borrow, and by setting periodic or lifetime rate caps.
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.
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 as long as you pay as agreed.
Read the closing papers carefully before signing. If the terms aren’t what you expected, don’t sign the loan. Ask questions or see if you can negotiate changes. If it’s not the right fit for you, don’t sign.
A HELOC loan can be a good option if you don’t need a large sum upfront, know how much you’ll need to borrow or when you’ll need it.
HELOCs may also have tax advantages unavailable with other loans. To learn more, talk to a tax adviser or an accountant.
If you need a lump sum upfront, you may want to look into other types of loans, such as:
Home equity loans
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 or less-than-stellar credit history, taking out a traditional loan may not be an option for you.
In that case, consider an equity-based product such as Unlock’s Home Equity Agreement (HEA). An HEA is not a loan, so there are no income requirements, monthly payments or interest.
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 improvement, settle a divorce, pay for your children’s education or anything else you’d like.
At the end of the term, typically around 10 years, you sell the property, and the HEA provider receives a share of the proceeds. This is often about 16%. If you don’t want to sell your home at that time, you can buy the HEA provider out.
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.
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, 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.