A Home Equity Line of Credit (HELOC) is a flexible form of credit that allows you to borrow against the equity in your home.
Here’s a breakdown of how it works:
What is a HELOC?
A HELOC is a revolving credit line based on the value of your home, minus any outstanding mortgage. You can typically borrow up to 85% of your home’s appraised value, and withdraw money as needed during the draw period (usually around 10 years). During this phase, you only pay interest on the money you use. Once the draw period ends, you enter the repayment phase (typically 20 years), where you repay both the principal and interest.
How Does a HELOC Work?
A HELOC functions like a credit card secured by your home equity. You can access funds using various methods, such as a credit card or digital transfers. You only pay interest on the amount you use during the draw period. After the draw period, you start repaying the principal and interest over time, and you can no longer borrow additional funds.
HELOC vs. Home Equity Loan
A key difference between the two is flexibility. A HELOC has adjustable interest rates and allows for ongoing borrowing during the draw period. A home equity loan, on the other hand, gives you a lump sum with fixed interest rates and monthly payments, making it better for specific, one-time expenses.
Qualifications and Costs
To qualify for a HELOC, you typically need a decent credit score (around 680 or higher), a low debt-to-income ratio, and 15%-20% equity in your home. While closing costs for a HELOC are generally lower than a mortgage, there are still costs like application, appraisal, and processing fees. It’s essential to check for any penalties for early closure or non-usage.
Disadvantages and Considerations
A HELOC offers flexibility but also carries risks. It reduces your home equity, which could lower your profits if you sell the home. Interest rates are adjustable, which can increase your costs, and fewer lenders offer HELOCs today. Always weigh the costs and benefits carefully.
