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What is a HELOC and How Do They Work?

line of credit

In 2018, the Federal Reserve Bank estimated that consumer loans across all commercial banks in the US were valued at over $1 trillion.

Americans use loans to purchase cars, send their kids to college, consolidate their debt, and for emergency reasons. If you need access to large sums for these or any other reason, you might consider a Home Equity Line of Credit (HELOC).

Before applying for a HELOC, you should understand how they function. Preparing yourself for applying, making payments, and accessing your money gives you more control over your finances.

Keep reading to learn more about HELOC’s and how they work.

What Is a Home Equity Line of Credit?

A Home Equity Line of Credit is more commonly called a HELOC. It’s a revolving line of credit that involves your home.

When you get a HELOC, you’re given access to credit based on the available equity in your home. In layman’s terms, you’re borrowing against the equity of your home and securing that loan by putting up your house as collateral. Which is why, if you stop making payments, you risk losing your home.

In that way, a HELOC is like a second mortgage. However, it functions more like a personal credit card.

You’re given a credit limit that’s set when you’re approved. You can draw as much or as little of that as you want, and you can pay it back the same way you pay back a credit card. Meaning, you can repay some or all of it monthly, and as you pay back your balance, the credit is replenished.

People generally apply for a HELOC to help them pay for large expenses or to consolidate their debt. HELOC’s are an excellent loan option for items with higher price tags because they have lower interest rates than other types of loans. The interest you do pay may even be tax deductible.

How to Qualify for a HELOC

Like any other type of loan, you’ll have to demonstrate to the lender that you can pay back the money you’re borrowing. To this end, your lender will likely check your credit score, credit history, monthly income, debts, and employment history.

To qualify for most loans, you will need a debt-to-income ratio of at least 28/36. A good credit score is usually 700 and above, but depending on the value of your home, your lender may consider lower credit scores as well. With that said, most importantly, you’ll need equity on your home.

Not only do you need equity, but you also need at least 85% equity. Equity refers to the home’s value minus how much you owe on your primary mortgage. For this, lenders will need to know your amount of equity as well as that the appraised value of the home is.

HELOC Fees

Before applying for a HELOC, ask the lender if there are any fees you’ll need to pay. Below, we’ve listed some fees banks have been known to charge:

  • Inactivity fees may be charged if you don’t use the account
  • Transaction fees may apply every time you borrow money
  • Membership fees or annual fees might be charged to keep the account open
  • Early termination or cancellation fees can be applied to accounts who close or cancel the account before a certain date
  • Minimum withdrawal limits can place limits on the amount you take out, so you pay interest in more money than you need
  • Minimum or required balances force you to have a certain balance or risk paying additional interest every month

You should also ask the lender if there’s any initial withdrawal minimum. Some lenders will require you to draw from the account within a certain timeframe.

Accessing HELOC Money

There are a variety of ways you might draw from your HELOC. Depending on your lender, you may be given:

  • an access card that functions like a credit card or bank card
  • a checkbook
  • a bill pay option
  • the option to transfer the funds from one account to another online

You will only be able to access up to the amount of your credit limit. The pre-determined credit limit will be part of your terms and based on your equity as well as personal financial situation and history.

Do You Need a Line of Credit?

A Home Equity Line of Credit is a great way to cover big expenses or consolidate your debt. To qualify, you’ll need a healthy credit score and history as well as equity on your home. As long as your finances are in order and your home’s value is higher than the amount you owe on your mortgage, you shouldn’t have any trouble qualifying for this type of loan.

Be sure to ask your lender about the terms of repayment as well as any fees you might face. You’ll also need to know how you’re going to access your money when you need it.

If you need access to a line of credit but aren’t sure where to start, start with us. Apply with us online for a HELOC.

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