What is a HELOC?
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What is a Home Equity Line of Credit (HELOC)?
How it Works
Like a credit card, a HELOC is a revolving line of credit that allows you to borrow up to a certain limit, pay it off, and then borrow it again during a pre-set term. That credit limit is determined by a percentage that the lender sets for you called the LTV (loan-to-value). The LTV is the ratio of how much you owe on your home versus how much it’s actually worth.
The amount of money that a bank will allow you to borrow for your HELOC will depend on what they set as their max acceptable LTV.
HELOC vs Credit Card
While it’s similar to a credit card, a HELOC works slightly differently. One difference is that HELOCs have a time limit. First, there’s the draw period. This is generally a 10-year period where you can use the available line of credit on a HELOC. You’ll need to make payments during this phase and those payments will often go towards interest only.
Second, is the repayment period. Once you reach this period, you’ll no longer be able to borrow money and will start repaying the principal you’ve accumulated. The repayment period generally lasts 10-20 years. If you decide to move before the repayment period is over, the remaining balance will be due when you sell your house.
Qualifying for a HELOC
In order to qualify, you’ll need to prove to your potential lender that you will be able to pay back any money you borrow. Your lender will consider your debt to income ratio (DTI), your credit score, and more. The lender that you choose for your HELOC does not have to be the same as your mortgage provider.
Taking the Risk
Before jumping headfirst into a HELOC, it’s important to be aware of the risks associated with it. First and foremost, a HELOC requires you to put your home up as collateral in exchange for the credit line. This means that if your situation changes drastically and you’re suddenly unable to make your payments, you risk losing your home. You also reduce your equity in your home when you take out a HELOC, as you are increasing the debt that you owe against it regardless of whether you use the line or not.
Plus, a HELOC isn’t free money. There may be fees associated with opening and maintaining it. Similarly, most HELOCs have variable interest rates. This means that they change with market factors. You may be able to start out with a low rate at the beginning, but it could rise to something that may be much less affordable.
Some institutions offer a conversion feature where you can convert some of the outstanding balance to a fixed rate and term during the draw period. This option can be useful if rates are expected to rise before you expect to pay that portion back.
Lowering & Freezing
Lenders can lower or freeze a HELOC. That means that if something happens that significantly changes things from when you first opened the HELOC, the terms of the HELOC could change as well. The lender can lower your approved amount or even refuse to allow you to borrow any more. Some situations where this could happen include if the value of your home drops significantly or if the lender has reason to believe that you will no longer be able to make your payments.
Deciding if a HELOC is right for your situation will mean considering all of your debt, your risk tolerance, and what you want to use the money for.
Is a HELOC Right for You?
Deciding if a HELOC is right for your situation will mean considering all of your debt, your risk tolerance, and what you want to use the money for. Some of the most common uses for a HELOC are to renovate/improve your home, finance education or consolidate debt. Interest on HELOC payments may be tax-deductible* and may have a lower interest rate than a credit card or other loan options, though that lower rate is not guaranteed to stay.
If you need extra funds and are comfortable with the idea of borrowing against the equity of your home, another option could be a Home Equity Loan. This loan works similarly to a HELOC but, rather than being a credit line, is a lump sum that you borrow and payback. If you feel the risks of tapping into your home’s equity are too great, you may want to consider other types of loans.
Learn more about CSB’s Home Equity Loans and Home Equity Lines of Credit.
Disclaimer
While we hope you find this content useful, it is only intended to serve as a starting point. Your next step is to speak with a qualified, licensed professional who can provide advice tailored to your individual circumstances. Nothing in this article, nor in any associated resources, should be construed as financial or legal advice. Furthermore, while we have made good faith efforts to ensure that the information presented was correct as of the date the content was prepared. CSB disclaims any liability arising from the use or misuse of these materials and, by visiting this site, you agree to release CSB from any such liability. Do not rely upon the information provided in this content when making decisions regarding financial or legal matters without first consulting with a qualified, licensed professional.