Everything You Need to Know About Home Equity Lines of Credit

Among the various perks that come with being a homeowner, one is watching your home’s equity rise while your mortgage loan amount decreases. With this built up equity, you can take advantage of borrowing against it in the form of a home equity line of credit, or HELOC for short, which allows you to use a percentage of your home’s equity to help pay for projects and large expenses. Maybe you want to finish your basement or are looking for an affordable way to help pay for your child’s college education. Whether you’re still in the process of paying down your mortgage or you own your home outright, a HELOC could be the perfect solution.

What is Equity?

Before going any further, let’s talk about equity. Equity is the amount of the home you own forthright. To get this value, subtract any outstanding loan balance from the market value of your home.¹ In other words, the more equity you have, the more options you’ll have to finance your home project or other expenses.

You can build your equity in two ways. The first way is to increase your property value. This occurs through rising prices in the home market and by making home improvements. The second way is to reduce the amount of debt owed on the home. This can be done by regularly making monthly payments on the home loan, making extra payments on the home loan, and choosing shorter loan terms to pay off your home faster.²

What is a Home Equity Line of Credit (HELOC)?

A HELOC is a flexible and convenient way to borrow funds against the equity built up in your home. A HELOC, similar to a credit card, is a revolving line of credit that can be used to pay for home improvements, large expenses, unexpected expenses, and debt consolidation. Essentially, you are borrowing money against your home’s equity.

How does a HELOC work?

Before deciding whether to apply for a HELOC, first determine how much equity you have in your home. Then, consider how much money you need and how you plan to use it. As you weigh your options, factor in: interest rates, fees, monthly payments – and of course, whether borrowing is the right approach at all.

When applying for a HELOC, the lender will evaluate your combined loan-to-value ratio (CLTV), income, credit, and any outstanding debts when considering how much you’ll be eligible to borrow.

Upon approval, you’ll enter the draw period where you can borrow from your line of credit in a variety of methods depending on what the financial institution offers, such as by: check, in person, card, or even by transferring money using Online Banking or a mobile app. Payments are only required if the line of credit is drawn upon and are often interest-only, but you may pay down the principal if you wish. Depending on the lender you work with, the length of this draw period can vary.

Following the draw period is the repayment period, during which borrowing from the line of credit is no longer available. Payments are due monthly and include both the principal and interest. During this time, the payments can rise sharply compared to the draw period due to the addition of principal payments. The length of the repayment period can vary and is determined by your lender. If you find you still need access to the line of credit, you may also have the option to reapply.

What can you do with a HELOC?

Typically, HELOCs are used for home improvement projects to help increase the overall value of a home. But, there are several use cases that make a HELOC a great financing option, including:

1. Increase the value of your home. The most common purpose of a HELOC is to help homeowners complete home improvement projects. Use a HELOC to finish your basement, add that extra guest bedroom, or make your kitchen HGTV-worthy. Not only will these renovations make your living space more comfortable, but the upgrades to the home could also increase the value of your home if you decide to sell it later.
2. Consolidate high-interest debt. If you feel burdened by mountains of debt, pay them off by consolidating into a single, more manageable payment. Create a full-proof repayment plan and stick to your set budget to make certain that your debts are paid off as intended.
3. Major purchases. Help pay for larger purchases, such as a new refrigerator or a furnace, with the help of a HELOC. With a HELOC, you’ll pay less in interest than if you were to charge the large purchase to a high-rate credit card.
4. Education expenses. College is expensive. If you’re a parent paying for your child’s education, consider opening a HELOC to help pay for: tuition, books, housing, and other college-related expenses. Due to the lower interest rates compared to that of federal, personal, or private loans, this makes a HELOC a great alternative.

What are the benefits of a HELOC?

1. No restrictions on how the funds are used. You can use the funds any way you wish. No justification or plans are needed like some other loan types. That being said, the funds should be used responsibly, as your home is on the line for the loan.
2. Borrow as you need it. Due to the nature of a line of credit, you’ll have ongoing access to your funds with no initial draw requirement and a 10-year draw period. And, you’ll only pay for the interest and money that you borrow.
3. Tax-deduction eligibility. A HELOC is a type of mortgage, which means the interest you pay may be tax-deductible if the money is used to “buy, build, or improve the home” that secures the loan.3 To be certain of how this applies to you, check with your tax adviser.
4. More cash in your pocket. HELOCs are considered a secure loan type, which means they have lower interest rates compared to unsecured loan options, such as personal loans and credit cards. This means you’ll likely pay less than other solutions.

Things to consider before getting a HELOC.

1. You could lose your home if payments aren’t made. When you open a HELOC, you are using your home as collateral. This makes it even more important to make payments on time, otherwise you run the risk of losing your home.
2. Monthly payments can be unpredictable. Typically, HELOCs are adjustable-rate loans so the interest rates can vary. If the interest on your rate increases, your monthly payments will increase as well. Before taking out a HELOC, determine the max interest rate you could be charged and if you could afford to make payments back if the rate were to reach that point.
3. There may be fees and penalties, such as:
   1. An annual fee. Even if you don’t withdraw any funds, you may be charged an annual fee to keep your HELOC open.
   2. An inactivity fee. You may be charged if you don’t use any funds in your available line of credit. Just be mindful of this when you’re reviewing your loan options.
4.  Large final payment. As you reach your repayment period, you are required to pay your HELOC in full, no matter what the remaining balance is. If you are unable to do so, you risk losing your home.

If you’re a homeowner, a HELOC could make a great option if you foresee large expenses in the future. With the flexibility, convenience, and tax-deduction possibilities a HELOC provides, you can better finance your upcoming projects and expenses without worrying about having enough money to cover the initial purchase. Just as you would with any other loan, consider the pros and cons to weigh your options.

If a HELOC sounds like something you might be interested in, meet with one of our Member or Relationship Consultants to discuss if it’s a good fit for your housing needs.