What Is a Home Equity Line of Credit?

Home Equity Line of Credit document

Homeowners can tap into their home equity in a variety of ways. One option is a home equity line of credit (HELOC) which can often be acquired at a lower interest rate than a personal loan or credit cards.

Here’s what you need to know about HELOCs, what they are, the downside, and some alternatives worth considering.

What Is Home Equity?

Equity is the difference between how much you owe on your mortgage and what your home is worth in the current real estate market. Let’s say your home is valued at $400,000, and you owe $50,000 on your mortgage. That means you have $350,000 in home equity you could access.

What Is a Home Equity Line of Credit?

A HELOC gives you a line of credit you can draw from that’s tied to your home’s equity. Your lender will set a maximum spending limit, and you decide how much or how little you want to tap into. Most HELOCs come with variable rates, but some lenders are now offering fixed-rate HELOCs.

With a HELOC, you only pay back what you borrow. For example, you may qualify for $50,000, but if you only borrow $10,000 of it, that’s all you’ll owe.

And you only pay interest on what you actually borrow. You can even activate a HELOC, never touch it, and never owe anything. Just knowing you could tap into it if you need to can give you peace of mind.

What Can You Do with a Home Equity Line of Credit?

HELOCs don’t typically come with spending restrictions, so you can spend the money on whatever you like. You could:

  • Supplement your retirement income.
  • Remodel your home, which can increase its value.
  • Consolidate your debt, especially paying off high-interest credit cards.
  • Finance a trip.
  • Help a family member pay off their college debt.

What Are the Disadvantages of a HELOC?

Like any loan, you need to be aware of potential pitfalls before you commit, and HELOCs often have a few, such as:

  • Banks can freeze a HELOC account in certain circumstances when property values decline. This can happen during market volatility or your credit rating declines.
  • Depending on the lender, some HELOCs can saddle you with a balloon payment.
  • If you’re considering refinancing your mortgage, you may have to pay off your HELOC first.
  • Miss a payment, and your lender could foreclose on your home.

Because of these disadvantages, many people consider a line of credit through a reverse mortgage like a home equity conversion mortgage (HECM). HECMs are insured by the Federal Housing Administration (FHA), and the program is regulated by the U. S. Department of Housing and Urban Development (HUD).

What Does it Take to Qualify for a HELOC?

Qualifications vary by lender but, in general, to qualify for a HELOC:

  • You should have at least 15-20% equity in your home.
  • You have sufficient income to pay back the debt.
  • You have a reliable history of timely credit payments.
  • Your credit score should typically be in the mid-600s or higher.
  • Your debt-to-income ratio is 43% or lower.

How Do You Apply for a HELOC?

To apply for a HELOC, you’ll have to supply certain documentation based on lender requirements. This may include:

  • Pay stubs or W-2s
  • Tax returns
  • Homeowner’s insurance policy
  • Tax bills
  • Credit reports
  • Mortgage statement
  • Proof of homeownership like the deed to your home or title insurance

If you have sufficient equity in your home and have a history of responsible credit repayments, a home equity line of credit can be a great option for you. But it’s always a good idea to research your options carefully and consult with an independent financial advisor.

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