HELOC Borrowing Basics: What to Expect
1. What is a HELOC?
A HELOC, or home equity line of credit, is a type of loan for homeowners.
Instead of borrowing money all at once, a HELOC gives you the option to borrow money when you want, up to the maximum limit.
For example, if you qualify for a $100,000 HELOC, you can borrow up to $100,000.
You can borrow that money all at once or take out multiple smaller loans as long as all the loans don’t add up to over $100,000.
Once you pay back the money, you can borrow it again.
Your bank will give you a checkbook or credit card that lets you spend through your home equity line of credit.
HELOC requirements
To qualify for a HELOC, you need to own your home and have equity in your home.
This means that the value of your house is higher than your remaining mortgage loan.
This is because the HELOC is secured by your house.
If you can’t pay off the loan, the bank can eventually seize the property.
The bank will also review your credit and income to make sure you can pay back the loan.
However, it’s easier and quicker to qualify for a HELOC than for a regular mortgage because you’re securing the loan with the value you own in your house.
After you borrow money, you’ll need to pay it back with interest. Different banks charge different rates for HELOCs.
There are online HELOC payment calculators which can help you with your research.
With these calculators, you enter in the value of your home and the amount you’d like to borrow.
The calculator will then tell you how much you’d have to make in payments and show you rates at different banks so you can find the best HELOC rates.
2. Features and Benefits of a HELOC
Why get a HELOC
One of the benefits of a HELOC is that it’s a flexible way to borrow money.
It’s convenient because you’ll have one more source of money when you need it.
At the same time, if you don’t need money, you don’t have to take out a loan and pay unnecessary interest.
A HELOC gives you the flexibility of a credit card with a much lower interest rate.
If you think you might need money from time to time going forward but aren’t sure exactly how much, a HELOC could be a good idea.
What’s also nice about a HELOC is that is can also help lower your taxes.
The interest on up to $100,000 borrowed through a HELOC is tax deductible. Interest on credit cards or regular loans is not tax deductible.
HELOC loan rates and costs
HELOC interest rates are a little bit higher than mortgage interest rates.
Also, HELOC rates are usually variable which means they change based on market interest rates.
In other words, your monthly payments can go up and down.
Banks adjust their HELOC rates more often than mortgage rates.
While banks usually only adjust mortgage payments every year, your HELOC payments can change every month.
For the start of your HELOC, typically the first 5 to 10 years, you just need to pay the interest on your loan.
After this initial period, you need to pay back the loan balance as well as interest.
HELOC costs tend to be lower than the costs to set up a mortgage because the application process is easier.
Many banks waive initial fees and just make money through your interest rate.
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3. What’s the Difference Between a HELOC and Home Equity Loan?
Home equity line of credit vs. home equity loan
A HELOC and a home equity loan are fairly similar. They’re both loans backed up by your home equity.
The key difference is a home equity loan gives you the money all at once while a HELOC gives you the option to borrow in smaller amounts over time.
Another important difference is that home equity loans usually have a fixed interest rate while HELOCs have a variable rate.
Your monthly payments on a home equity loan will stay the same while payments on a HELOC will go up and down.
When you borrow the same amount of money, your payments on a home equity loan will start out higher.
However, over time you’ll end up paying more for a long-term loan through a HELOC as the payments eventually go up.
When to consider a HELOC vs. home equity loan
A home equity loan works better than a HELOC when you know exactly how much you want to borrow and you want a set payment plan.
For example, if you need $50,000 for home renovations and want to pay the money back over 5 years, it makes more sense to take out a 5-year home equity loan.
If you’re not sure how much you want to borrow and you want to take out multiple small loans going forward, a HELOC makes more sense.
That way you can borrow when you want and can pay the money back on your schedule.
You also won’t be wasting money by paying interest on money you didn’t need to borrow.
4. The Best Ways to Shop for a HELOC
Best HELOC rates
When you are considering a HELOC, it’s important to shop for the best HELOC rates.
Banks charge different interest rates and even finding a slightly better deal can lead to hundreds of dollars in savings over the years.
Remember, you don’t have to take out your HELOC with the lender that’s in charge of your mortgage.
A HELOC is a completely separate arrangement so you can take yours out with the lender that offers the best deal.
You should get estimates of HELOC rates with different banks and credit unions on MyBankTracker’s HELOC page.
That way you can narrow your search and only officially apply with the lenders with the lowest HELOC rates.
Compare HELOC terms as well
The HELOC interest rate shouldn’t be the only part of your decision. Lenders can charge extra fees for these loans.
The best HELOC lenders aren’t necessarily the ones with the lowest rates.
If a lender charges a number of fees to launch the HELOC, this could wipe out any benefit from a low interest rate.
Also, check for extra rules and restrictions after you launch the HELOC.
For example, some loans charge an extra fee if you don’t borrow a minimum amount over time, known as an inactivity fee.
Subprime HELOC lenders
If your credit score is low, you might have trouble qualifying for a regular HELOC.
While it’s easier to qualify for a HELOC than for a regular mortgage, lenders still look at your credit score as part of their decision.
If you can’t qualify, you can try applying with a subprime HELOC lender.
These lenders charge a higher interest rate in exchange for accepting a lower credit score.
5. What Types of Fees Are Involved
HELOC application fee
Lenders can charge a number of different HELOC fees on top of the interest rate. Some lenders charge a fee to process your application for a HELOC.
This covers the cost of handling your paperwork and looking up your credit score.
Appraisal fee
Since your HELOC is backed up by your home equity, lenders need to know the value of your house before you can qualify. They could charge you a fee for the cost of appraisal.
Annual fee
Lenders might charge an annual fee for keeping your HELOC open. You’ll need to pay this fee every year regardless if you borrow money or not through your HELOC
Cancellation fee
When you take out a HELOC, you set it up to last for a number of years, somewhere between 5 to 30 years. If you cancel your HELOC, usually because you sell your house, the lender could charge you a cancellation fee for shutting down early.
Inactivity fee
When lenders set up a HELOC, they expect that you’re going to borrow money through it so they can earn interest. Your HELOC might charge an inactivity fee if you go too long without borrowing money.
Repayment fee
This is similar to the inactivity fee. If you borrow money through your HELOC and pay the loan back too quickly, the lender might charge a repayment fee because they didn’t make much interest. Your HELOC terms would outline how long you’d need to keep a loan out to avoid the repayment fee.
Some or all these fees can be avoided with the right lender which is why it’s a good idea to shop around for your HELOC.
