A home equity line of credit is a type of revolving credit in which the home is used as collateral. Because the home is more likely to be the largest asset of a customer, many homeowners use their home equity line of credit for major items such as home improvements, education, or medical bills rather than day-to-day expenses.
With a home equity line of credit, the borrower is allowed to borrow a specific amount of credit. However, there is a credit limit that the lender sets by taking a certain percentage of the home’s appraised value and subtracting it from the existing mortgage’s balance.
Here is a calculator you can use to see how much credit you may qualify for at a variety of loan to value (LTV) ranges.
|Enter Your Current Mortgage Information|
|Loan to Value||Cash Out Limit|
Financial institutions loan to different limits depending on market conditions. Typically the maximum allowable LTV is in the 75% to 80% range, but some financial institutions may lend as high as 100% to select customers with strong credit profiles.
Once you have figured out your cash out limit, you can then consider how much you want to access & how you may want to repay it.
Home equity loans are just like a traditional conforming fixed-rate mortgage. They require a set monthly payments for a fixed period of time where a borrower is lent a set amount of money upfront and then pays back a specific amount each month for the remainder of the loan. Equity loans typically charge a slightly higher initial rate than HELOC do, but they are fixed loans rather than adjustable loans. If you are replacing your roof and fixing your plumbing and know exactly what they will cost upfront, then a home equity loan is likely a good fit.
HELOC offer greater flexibility, like the ability to pay interest-only for a period of time, and then switch to a regular amortizing or balloon payment. When you have a HELOC you may be charged a small nominal annual fee - say $50 to $100 - to keep the line open, but you do not accrue interest until you draw on the line. HELOC loans are better for people who are paying their child's college expenses each year and other types of staggered periodic expenses. Be aware HELOC rates are variable and change as the Federal Reserve adjusts the Fed Funds rate, so monthly costs may jump significantly if you shift from interest-only to amortizing payments around the same time the Federal Reserve does a significant rate hike.
Which option should I choose? HELOCs are better for people who need to borrow various amounts of money periodically, whereas home equity loans are better for people who intend to borrow one known sum of money once for a known fixed amount of time.
|Loan Type||Home Equity Loans||HELOC||Cash Out Refi|
|Interest Rate||Fixed||Adjustible (in most cases)||Fixed|
|Draw Money||Lump Sum||As needed, througout draw period||Lump Sum|
|Tax Deductible Interest||Yes*||Yes*||Yes*|
|Interest Only Payment||No||Yes||No|
|Interest On||Loan Amount||Amount Drawn||Loan Amount|
* provided the debt is obtained to build or substantially improve the homeowner's dwelling.
Some banks offer hybrid products where borrowers do not owe until they draw on the line, but then structure the loan to be fully amortizing. When borrowing large sums of money many borrowers choose cash out refi rather than a home equity loan. The following interactive table highlights local refinance rate offers from banks and credit unions in your region.
The fixed amount of money repayable by a second mortgage is done over a fixed period of time. In many cases, the payment schedule calls for payments of equal amounts to be paid throughout the entire loan period. One may decided to take a second mortgage rather than a home equity line if, for example, the set amount is needed for a certain purpose such as building an addition onto the home.
However, deciding which type of loan suits the need of the customer involves considering the costs that come along with two alternatives. It is important to look at both the APR and all other charges. The APRs on the two different types of loans are figured in different ways:
Some plans have minimum payments that cover a certain portion of the principal, the total amount borrowed, plus any accrued interest. Unlike the usual installment loan, the amount that goes toward the principal may not be sufficient enough to repay the principal amount by the end of the term. Other plans may allow payments to be made on the interest a loan during the life of the loan, which is referred to as interest-only loans. This means that the borrower pays nothing toward the principal. If the borrower borrows $10,000, that means they will owe that amount when the plan comes to an end.
The borrower may choose to pay an amount higher than the minimum payment, so many lenders may offer a choice of payment options. Many consumers choose to make payments on the principal on a regular basis just as they do with loans. For example, if the consumer uses their line of credit to buy a boat, they may want to pay it off just as they would a typical boat loan, which saves more money in the long run.
Whether the payment arrangements during the life of the loan is to pay a little or pay none toward the principal amount of the loan, when the plan comes to an end the consumer may be required to pay the entire balance all at once. The consumer must be prepared for this “balloon payment” by refinancing that amount with the lender, by obtaining a loan from a new lender, or by other means. If the consumer is unable to make the balloon payment, then they risk losing their home. The consumer must consider how the balloon payment is going to be made prior to entering the loan agreement.
There are several reasons as to why the consumer should consider a home equity line of credit and many different reasons as to why borrowers use them:
Depending on the creditworthiness of the borrower and the amount of outstanding debt, the home equity lender may let the borrower borrow up to 85% of the appraised value of the home minus any amounts still owed on the first mortgage. The lender should be asked about the length of the home equity loan and if there is a minimum withdrawal requirement, as well as if there is a minimum amount or maximum amount to withdraw after the account is opened. The borrower must know in what methods the credit line can be accessed such as credit cards, checks, or both.
HELOC typically charge a higher rate of interest than traditional fixed-rate mortgages. If you intend to borrow a significant amount of equity for an extended period of time, it may be more cost effective to refinance your mortgage. This is especially true if your original mortgage was obtained when rates were well above their current historically low levels. It is also worth reiterating that traditional home mortgage debt allows the homeowner to deduct the interest payments on up to $750,000 of debt from their income taxes, while both HELOCs and home equity loans are not tax deductible unless it is obtained to build or substantially improve the homeowner's dwelling.
There are both advantages and disadvantages to a home equity line of credit. The following are things to look for when considering such an action: