6/9/2023
A home is an important asset that can be used to obtain financing on more favorable terms. For this purpose, in the United States there are home equity lines of credit or HELOCs.
In this article we tell you what they consist of, their requirements and how to contract them.
What is a HELOC or home equity line of credit?
A Home Equity Line of Credit or HELOC is a financial instrument that uses a property you own as collateral. It works like a revolving loan that lets you take out money up to a set maximum limit.
- Interest: Adjustable, from Prime + 1.45% to Prime + 6%
- Max term: 20 años
- Interest: Fixed or adjustable
- Max term: Consultar
- Interest: 7.95%
- Max term: Consultar
- Interest: Fixed or adjustable
- Max term: 30 años
- Interest: 5.74% APR for the first 6 months, then adjustable, currently at 8.75% APR
- Max term: 20 años
Through this line of credit, you request money based on the equity or capitalization of the home, which is the current value of your property minus what you still owe on your main mortgage, if you are still paying it, since you can also make use of this financing if you have already finished paying it.
Requirements for a HELOC
Naturally, each lender requires a series of conditions that may vary when you apply for a HELOC. Generally, they ask for:
- Credit score of 620+.
- Debt-to-income ratio below 40%.
- Appraised value of the property that exceeds 15% of what you owe.
How much can you get with these lines of credit?
The maximum amount of a HELOC varies depending on the current value of your home and the percentage the lender will give you of the mortgage. To get a better idea, you can use two simple formulas to calculate the maximum amount:
- Present value of your property times the percentage the lender gives you.
- Maximum amount of principal you can borrow minus the remaining balance of your mortgage.
For example, let's say your home is valued at $200,000, the remaining balance on your primary mortgage loan is $100,000 and the lender is offering you 80% of the appraised value of the property. If you multiply 200,000 x 80% (0.80), this gives you 160,000.
Now you only have to subtract what you owe to get what you can get, which would be $60,000 at most.
How do you pay off a home equity line of credit?
Similar to a credit card, the HELOC dynamic has 2 stages:
- Withdrawal time. You can withdraw money from the available amount by check, transfer or a card associated with the account. At this stage there is a minimum monthly payment which is usually interest only, but you can also pay the principal balance. Just as some lenders give you 3 years to withdraw, others may give you 10.
- Repayment time. When it's your turn to repay, you can't withdraw even if you have the money available. You must first repay what you owe in monthly installments that include interest and principal balance. The term can extend up to 20 years and the monthly payments are higher than at the time of withdrawal.
When is it not a good idea to request a HELOC?
It is important to understand that requesting a HELOC increases the risk of default on your primary mortgage. Therefore, it is better to use other financing options in the event that:
- You can't afford the upfront costs. These lines of credit require appraisal, title search, application fee, points and real estate attorney fees.
- You don't need a lot of money. The upfront costs of a HELOC don't justify asking for a line of credit with a small balance. In any case, a credit card with 0% APR for 12 months or more is better.
- You have an irregular income. When you think your income is not going to improve soon or could get worse, a home equity line of credit is not a good idea. If you can't pay, you could become homeless.
- You want to use the money for basic needs. We do not recommend a HELOC for additional credit for everyday purchases or to make up for a lack of liquidity. It is an unnecessary risk, being preferable that you organize your finances better.
- You cannot afford the interest rate increase. These lines of credit have a variable interest rate and the conditions reveal the maximum during their duration. If in your calculations you think that you will not be able to deal with this limit, it is better to look for other options.
Loan or line of credit?
In addition to lines of credit, it is also possible to find home equity loans, which differ in the same way that lines of credit and personal loans differ, and which you can consult in this article.
This decision depends largely on the general state of your personal finances, priorities and needs. The HELOC is indicated for those who have ongoing expenses or those who prefer to repay without so much haste. The advantage is that you draw when you need to and the repayment term is usually longer.
On the other hand, the home equity loan offers you greater certainty about the amount of the monthly payments. This is because you receive a certain amount of money all at once and then pay it back in monthly installments with a fixed interest rate. If you want more predictability while putting up your home as collateral, this option is more suitable.
Español: ¿Qué son las HELOC (líneas de crédito hipotecarias)?