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Your Questions About Home Equity Lines of Credit
For many people, a home is their largest asset. The value of your home minus your loan is called equity, and it is the portion of your home that you actually own. Sometimes homeowners want to access that equity to do things like renovate their kitchens, fix a leaky roof, or pay off high interest debt. And, that’s possible through products like home equity loans or a home equity line of credit (HELOC).
What is a home equity loan?
A home equity loan is a lump sum loan similar to a personal loan. Home equity loans usually have a fixed interest rate and fixed monthly payments that you pay back over a period of time. They’re different from HELOCs, although sometimes people use the terms interchangeably. One of the biggest differences is HELOCs often have variable interest rates with no fixed payments. Like HELOCs, home equity loans are also called second mortgages. You should have good financial habits established before taking out a home equity loan because you’ll be receiving a large lump sum payment to manage versus drawing on credit only as needed like with a HELOC.
What is a HELOC?
A HELOC is a revolving line of credit secured by the equity in your home. It’s credit that you can apply for and use should you need it. It works similar to a credit card. When you have a credit card, you can choose to use it or not use it. When you borrow money using your credit card, you can pay it back in full or pay a minimum monthly payment. Usually, a bank charges you interest on the amount you’ve borrowed. It’s similar when it comes to HELOCs. HELOCs typically have variable interest rates and you can borrow large amounts depending on how much equity you have in your home and your credit profile. Sometimes, a HELOC is also called a second mortgage.
How does a HELOC work?
You apply for a HELOC with a lender. The lender will look to see how much equity you have in your home and will check your credit. If you have enough equity and a good credit rating, your lender might offer you a HELOC. You won’t receive a lump sum payment like you would with a loan. Instead, you will be given access to use a line of credit up to a certain amount. If approved, you can typically borrow no more than 85% of your house’s value minus the outstanding balance on your home, although this can vary from lender to lender. HELOCs vary in terms of repayment requirements too. Typically you only have to make interest only payments in what’s known as a draw period (commonly 10 years) and after the draw period is over, you have to make interest payments along with principal payments. Some lenders have longer 15 year draw periods. Just like with any loan, it’s a good idea to pay more than just interest when repaying a debt to help you pay it off faster.
What should I do before applying?
Before you apply for a home equity line of credit or a home equity loan, you should:
- Know how much equity you have in your home. You need to have at least 20% equity to apply for a HELOC or home equity loan. Sometimes a lender will require an official appraisal of your home while others will not.
- Make sure you have good credit. Check your credit report to make sure it’s accurate and that you have no collections. It’s best to apply for a HELOC or home equity loan with a clean credit history.
- Check your budget. Although HELOC payments are lower during the draw period because you can make interest only payments, they will typically rise after that. Home equity loan payments are different. They’ll be the same payment for the duration of the loan. Either way, make sure that adding a HELOC or home equity loan payment won’t cause you to be too overextended financially.
What are the risks?
The main risk when taking out a HELOC or home equity loan is that you’re taking out a second mortgage using your house as collateral. If you are unable to pay back these loans, it’s possible you could lose your home. Additionally, if you decide to move, you’ll be responsible for paying off these loans. Typically you can pay them off using the sale of your home, but if there is a market dip and your home drops in value, that could affect your ability to pay the HELOC or home equity loan back.
What happens if I get denied a HELOC or home equity loan?
If you get denied one of these products due to your credit, you can always take the time to improve your credit and then re-apply. Sometimes people get denied due to a mistake on their credit report. That’s why it’s important to review your report and your credit score before applying so you know where you stand.
Will this loan affect my credit score?
A HELOC is a revolving credit account and a home equity loan is a loan. Both will appear on your credit report after you take one out. Anytime you apply for new credit, it’s possible your credit score will take a dip, but research shows it can rebound so long as you make your payments on time. Payment history, a.k.a on time payments, is the biggest factor that contributes to your overall credit score.
Is there a penalty for paying off my HELOC or home equity loan early?
This varies from lender to lender. If paying off the loan early is important to you, make sure to work with a lender who won’t penalize you for that.
Should I get a HELOC or home equity loan?
Which loan product is best for you depends on your personal finances and goals. Take the time to compare both of these products. Ask your lender what the fees are for each one, if there are closing costs or origination fees, etc. Once you have these answers and have spoken with 3-5 lenders, you’ll be better able to assess which of these products is best for your and your future goals.
How do I get started?
Decide whether or not you want a home equity loan or a HELOC. Then, check your credit report. If your credit report seems accurate and you’re ready to apply, contact 3-5 of the best HELOC or home equity loan lenders listed above and they can help you through the process.