As a homeowner, you may have heard the term HELOC mentioned when seeking out credit sources, looking into loan options or exploring refinancing. Despite its prevalence and popularity, you may not understand what a HELOC is and what it can provide to those who qualify. Whether you’re looking to consolidate your debt, finance post-secondary education or complete home renovations, a HELOC could be a great solution for your personal financial situation.
What Is A Home Equity Line Of Credit (HELOC)?
HELOC stands for home equity line of credit. To put it simply, it’s a revolving line of credit that lets you borrow the equity in your home at a much lower interest rate than a traditional line of credit. You’ll have to pay interest on the money you borrow through a HELOC but you’re able to borrow and repay over and over as you need cash, up to a certain maximum credit limit. The lender uses your home as a guarantee that you’ll pay back money that you borrow.
Aren’t sure what home equity is and if you have any to access? Essentially home equity is the amount of ownership of your home that you’ve built up through the years as you made your mortgage payments. You can calculate your home equity by taking the current market value of your home and subtracting the remaining balance of your mortgage. To apply for a HELOC, you must have at least 20% equity built up in your home.
Different Types Of HELOCs
There are a few different HELOC options you’ll encounter if you’re looking for ways to access the equity in your home. Be sure to do your research so you can determine which type is best suited for your personal needs.
HELOC Combined With Mortgage
You can actually use a HELOC to partially finance your home purchase alongside a fixed-term mortgage. You’ll need a 20% down payment or 20% equity in your home.
When combining with a mortgage, the portion of your home that you can finance with your HELOC cannot be greater than 65% of its purchase price or market value. While you can finance your home up to 80% of its purchase price or market value, the remaining amount above 65% must be on a fixed-term mortgage.
A standalone HELOC is not related to your mortgage at all and is a revolving credit product that is guaranteed by your home. For this option, you can get unlock up to 65% of your home’s purchase price/value and it won’t increase as you pay down your mortgage principal.
Pros Of Getting A HELOC
A HELOC will give you access to up to 65% of your home’s value in cash which you can use for home renovations, debt consolidation, education, or anything else you may need to fund. Some notable pros include:
– They make it very easy to access your available credit and often allow you to do so at much lower interest rates than other types of credit
- You can pay back what you borrow at any time with no penalty
- You only pay interest on the money you actually borrow
- You’re free to borrow as much or as little as you like, as long as it’s within your limit
- It provides you with the ability to consolidate your other debts as the interest rates are typically much lower
Cons Of Getting A HELOC
Qualifying for and using a HELOC isn’t always smooth sailing so it’s important to understand some of the notable disadvantages you may encounter:
- It will require discipline to pay off
- If you miss payments, your lender can take possession of your home as collateral
- With access to so much credit, it can be difficult to manage your spending and debt
- If you want to switch your mortgage to another lender down the line, you may have to pay off your full HELOC to do so
How To Qualify For A Home Equity Line Of Credit
Unlike your mortgage, which runs on a certain term, you only have to qualify for a HELOC once, and after you’ve been approved, you can access your home equity whenever you need to. If you’re considering applying for a HELOC, you’ll need to make sure you have a minimum of 20% equity in your home or a minimum of 35% if you plan to use a stand-alone home equity line of credit to replace a mortgage.
You’ll want to make sure you have a good credit score, a low debt-to-income ratio and can provide proof of stable income. You’ll also have to provide proof that you own the home, mortgage details and a current assessment of your home’s value (which your lender can assist with).
The bank will also subject you to a stress test to ensure you can make payments at the higher-than-average interest rate as the rates for HELOCs are typically higher than the rate in your current mortgage contract. There’s no regulation for banks or credit unions when it comes to choosing this stress test, so to be prepared. It’s helpful to know that they’ll have to use the higher interest rate of 5.25% OR the interest rate you negotiated with your lender + 2% extra.
If you’re looking to access your home’s equity to fund home renovations, education, consolidate debt and more, a home equity line of credit may be a great solution. Connect with your lender to learn more about your options and take the time to make a clear plan outlining your goals, budget and intentions before you make any big financial decisions.