What is a Home Equity Line of Credit (HELOC)?

Many homeowners may not be aware of the potential lying dormant in their own homes: home equity. Home equity is the difference between your home’s current market value and all outstanding loans and liens secured by your home. After continuously making your mortgage payments, and possibly even seeing your home increase in value, you are likely to have built up home equity.  

That home equity that you’ve been building has the potential to give you access to financial tools like the home equity line of credit (HELOC). What is a HELOC? A HELOC is a revolving line of credit, similar to a credit card, that you borrow against the equity in your home.  

HELOCs are usually second mortgages behind the first lien mortgage lender. However, if you own your home outright with no first lien mortgage, you can take out a HELOC in the first-lien position. 

In this article we will explain how HELOCs work, some of the qualifications for a HELOC, and the difference between a HELOC and a home equity loan (HELOAN).

How HELOCs Work

Borrowers will typically need to put their primary residence down as collateral for a HELOC. Lenders might vary on the property types they deem eligible for this loan (such as a second home or investment property). Some lenders accept an investment property as collateral for a HELOC, however, they are considered riskier and typically have higher interest rates and fees.   

At The Federal Savings Bank, only your primary residence or second home is eligible as collateral for a HELOC. Under certain circumstances, you may need to get a new appraisal of your home done to determine its current value.  

Once you have been approved for a HELOC, you will be able to access the revolving line of credit during what is known as the draw period. The length of the draw period varies depending on the terms of your HELOC.  

During the draw period, you can withdraw funds as needed (up to your approved credit limit) while only needing to pay interest on the amount you’ve borrowed. However, you are allowed to pay the principal, too, if you want to make your repayments a bit more manageable down the line.  

After the draw period ends, you will enter the repayment period. During the repayment phase, you will not have access to the funds since withdrawals are no longer permitted. You will need to repay what you borrowed.

Benefits of a HELOC

HELOCs provide a means by which homeowners can turn their equity into accessible cash. The cash made available in a HELOC can be used for whatever financial needs or goals the homeowner has during the draw period. Common examples of things funded by HELOCs include: 

• Home renovations 

• Medical expenses 

• Buying an investment property 

• Debt consolidation 

• Building an emergency fund 

However, those are just a few examples. Another benefit of a HELOC to consider is that it will typically have a lower interest rate than a credit card, hence the common use of a HELOC to pay down credit card debt.  

Also, with a HELOC, you repay only what you borrow, so if you don’t use the full amount allotted in your HELOC, you won’t have to repay the full amount. You do not have to spend your money all at once, either.  

Finally, depending on your home equity and other financial factors, a HELOC may provide a higher line of credit than you might receive on a credit card.

Variable vs. Fixed Interest Rate

HELOCs are usually an adjustable, or variable, interest rate-based product, but depending on your risk profile, fixed-rate options could be available. A fixed interest rate would provide you with more predictable payment amounts during repayment, as the interest rate would remain unchanged over the life of the loan.  

A variable interest rate, the more common type for a HELOC, can fluctuate over time depending on market conditions. This can potentially make your payments a bit more unpredictable.  

If your HELOC features a variable or adjustable interest rate, it’s important to prepare for changes in your rate over time.

Qualifying for a HELOC

Qualifications are likely to differ from one lender to another. However, we require the following, among other criteria:  

• Must be a United States citizen or permanent resident alien 

• Maximum debt-to-income (DTI) ratio of 45% 

• Minimum FICO credit score of 680 

• Combined Loan-to-Value (CLTV) of 90% or less on primary home, 80% or less on second home 

• Must be current on all loans 

• No significant derogatory credit 

Of course, to receive a home equity line of credit, you will also need to demonstrate that you have enough home equity.

How Much Can I Borrow with a HELOC?

Borrowers can work within a minimum of $50,000 and a maximum of $500,000 for a HELOC. The amount you can borrow will ultimately depend on your equity, your financial profile, and other factors assessed by your lender.

HELOC vs. HELOAN

Another way to tap your home equity is through a home equity loan (HELOAN). Though the money can be used similarly to finance a variety of financial goals, HELOANs and HELOCs differ in a few key ways.  

The loan amounts are the same ($50,000 to $500,000, except for Texas borrowers with a $60,000 minimum), but the loan terms are not. Since HELOANs typically have a fixed rate, repayment will generally be more predictable than a variable rate loan—which many HELOCs are. 

Further, instead of a revolving line of credit from which you would withdraw during a draw period, the HELOAN gives borrowers a lump sum of cash at closing. As such, many borrowers go with a HELOAN when they have a specific, big project or expense they want to fund all at once.

Final Thoughts

When homeowners are faced with big projects or expenses, it might be worth looking into a home equity line of credit (HELOC) for financing. This loan type comes with many benefits, including that it is a revolving line of credit, that it generally has a lower rate than a credit card, and that you only repay what you borrow. If it seems like a HELOC could help you achieve your goals, talk to a trusted lender to determine what that might look like for you.  

Disclaimer: Subject to credit approval. Terms and conditions may apply. Property insurance is required. A HELOC is a revolving line of credit secured by your home. Borrowers can draw upon the credit as needed during the Draw Period and are only required to pay interest on the amount borrowed. Upon submission of a full application, a mortgage banker will review and provide you with the terms, conditions, disclosures, and additional details on the interest rates that apply to your individual situation. Closed-end second mortgages, home equity loans, and cash-out refinance loans are not a revolving line of credit like HELOCs, and typically provide a single, lump-sum payment at closing that is repaid with a fixed rate in regular installments over a set term, similar to a traditional mortgage.