Your home equity is one of the most valuable assets that can be helpful when you are in financial distress. Many homeowners often use a home equity line of credit (HELOC) to finance various expenses such as home improvements, education fees, vacations, and medical bills.
Before borrowing money against your home equity, it is essential to understand how HELOC works. That will not only improve your knowledge but also help you to get the best mortgage deals from reputable lenders.
In this article, we’ll take a look at the definition of a home equity line of credit and how it works. You will also get to understand why you should or should not take a HELOC.
A home equity line of credit (HELOC) is typically a second mortgage that functions like a credit card. The HELOC allows you to borrow funds against your home equity, meaning you can qualify for large amounts of funds when you have more equity in your home.
You are probably wondering, what is home equity? It is the difference between the current value of your home and your outstanding mortgage balance. For instance, your home equity is worth $200,000 if the present value of your home is $350,000 and you have a mortgage balance of $150,000.
When taking out a HELOCs, you only use your home as collateral, and your lender may seize it if you default payments. Unlike mortgages, HELOCs have nothing to do with real estates. You can use the funds to finance various expenses.
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With a home equity line of credit, you only pay interest on the amount of money you owe. For instance, if your HELOC is worth $90,000 and you borrow only $30,000 of it, you will only pay interest on that $30,000. However, you can still borrow up to $90,000.
When applying for a home equity line of credit, lenders must always verify if you qualify by evaluating your home equity. They also have to consider the appraised value of your home, your income, credit score, and outstanding debts.
Lenders prefer working with borrowers who can pay off debts. For that reason, you have to demonstrate that you can repay the HELOC by providing proof of employment or income. You must also have a good credit score to qualify for the HELOC.
You can borrow high amounts of money with a HELOC if your home equity is high. As you pay off your mortgage, your home equity is likely to increase over time. That is also possible when your home appreciates with time.
With a HELOC, you can cash out up to 85% of your home equity. However, that may vary depending on the location and terms of lenders. In Canada, you can cash out a maximum of 65% of your home’s current value if your lender is a federally regulated institution.
If the lender combines your HELOC with your mortgage balance, you can borrow up to 80% of your home value. The interest rates for most HELOCs are variable. They can either increase or decrease depending on the prime rate.
For example, if your home is worth $500,000 with a mortgage balance of $300,000, you can a HELOC of up to $100,000 if the lender allows you to cash out 80% of your home equity. Check the illustration below.
The maximum home equity line of credit that you can get is worth $100,000.
When applying for a HELOC, you are likely to incur additional charges including the upfront lender fees such as appraisal fees, origination fees, application fees, and attorney’s fees.
Other fees may include the transaction fees, early account closing fees, title insurance fees, legal fees, and inactivity fees. Not every lender will charge all these fees. Some lenders may also charge membership fees to keep accounts open.
One of the primary factors that lenders consider before giving out a HELOC is home equity. Other factors such as your income, credit score, and outstanding debts may vary depending on your lender’s specifications.
You must have a good credit score to qualify for a home equity line of credit. Some lenders also consider debt-to-income ratios to determine eligibility for HELOCs. As a result, some retirees find it difficult to qualify.
In a nutshell, let’s look at some of the requirements that you must fulfill to get a HELOC.
While a home equity line of credit might help you pay your utility bills, you must be careful. You may find yourself in a debt trap and also lose your home when you fail to make payments on time.
Lenders have different rates and terms of payments. You should choose a lender who offers the best deals such as low-interest rates. LoansGeeks is one of the best places to find loan offers that will work best for you.
By Taylor Wilman