Do you need cash to cover an unexpected financial need or a home renovation that’s been long overdue? A home equity line of credit (HELOC) may be the answer to the emergency funding you need. A HELOC is ideal for people who need cash over some time and who are willing to use their home as collateral for the loan.
Many consumers choose HELOC instead of using their credit cards because of the huge difference in their interest rates. A home equity line of credit comes with an average rate of 4.53% while credit cards charge an average rate of 16.32%.
How long does it take to get approved for a home equity line of credit? You may have to wait between 14 and 28 days for your home equity line of credit application to be approved. However, certain factors, such as verification of the information you’ve provided and the appraisal process, will affect your approval time. How long you can access your funds upon closing will depend on your lender.
What is a Home Equity Line of Credit?
A home equity line of credit (HELOC) is a revolving line of credit that’s secured by your home. It is a type of loan that lets you borrow cash against your home equity, which is typically up to 85% of your home’s value minus the amount you owe on your first mortgage.
How Does a Home Equity Line of Credit Work?
A HELOC gives you access to a line of credit within a specific time frame called the draw period (or the time frame when the line of credit is available). In terms of the payment, you can choose to pay interest only during the draw period or pay both principal and interest rates. Once the draw period comes to an end, the repayment period begins. You’ll be expected to pay the outstanding loan balance and any interest owed.
The draw period is up to 10 years. Once it’s over, you will start paying back the loan with interest, and this generally lasts for up to 20 years.
How to Find the Best Home Equity Line of Credit Rates?
HELOC rates are cheaper than credit card interest rates, which is one of the reasons a lot of homeowners prefer a home equity line of credit. The average HELOC rate as of December 2020 is 4.53%.
These factors determine your HELOC rate:
- Creditworthiness – Your credit history and credit score will play a major role in determining your HELOC rate. Lenders offer lower rates to people who have a good credit score. If you currently have a poor credit standing, it’s best to improve your rating first before applying so that you’ll have higher chances of getting approved.
- Home Equity – You’ll make a better impression on the lender if you have more home equity.
- Rates Vary Between Lenders – Lenders have different HELOC rates so don’t forget to shop around to find the best deal.
Are HELOC interest rates tax-deductible? Yes, they are, as long as you spend the loan funds on home renovations. To be eligible for tax deductions, you also have to spend the money on the property that is securing the loan.
What are the Common Uses of a HELOC?
Most homeowners apply for a home equity line of credit so that they can use the funds for the following purposes:
- Home improvement projects
- Medical expenses
- Education expenses
- Debt consolidation
- Large purchases
What Do You Need to Apply for a HELOC?
The requirements for a HELOC application vary between lenders, but generally, you must have the following:
- At least 15% of home equity
- A credit score of at least 620
- A debt-to-income ratio of less than 43% (your debt should not exceed 43% of your income)
- A stable and sufficient income based on the lender’s standards (it varies, so prepare proof of your salary and other sources of income)
- A history of making reliable and timely payments
What are the Benefits of Using a HELOC?
Many people turn to a home equity line of credit because of the many benefits it has to offer. Here are some of them:
- HELOC comes with lower closing costs and additional fees than other types of loans.
- Making complete and timely HELOC repayments can help improve your credit score.
- HELOC is a flexible type of loan that allows you to borrow money whenever you need it.
- You can decide where you want to use the funds.
- You can choose to pay the principal and the interest, or interest-only during the draw period.
What are the Risks of a HELOC?
Just like any other type of loan, HELOC also comes with certain disadvantages, such as the following:
- Since you’re using your home as collateral for the loan, you may lose your house if you default on payments.
- HELOCs generally have a variable interest rate, which means your monthly payments will increase if the interest rate increases.
- Unpredictable monthly payments may lead to financial instability in the future.
- HELOCs will allow you to access a sizable amount of cash. Knowing that you can easily access that much cash may tempt you to live beyond your means. You may end up making large purchases that you won’t be able to cover in the future.
What Factors Do You Need to Consider When Looking for a HELOC?
- Interest Rate – HELOCs generally have a variable interest rate. As the name suggests, the interest rate may increase or decrease depending on the index, such as the prime rate. You need to know what the initial interest rate is and how long it’ll last. Don’t forget to check what the interest rate will be afterward.
- Rate Index and Markup – The interest rate of a home equity line of credit depends on a certain rate index and the markup. For example, you’ll be asked to pay for a 5% interest rate, which consists of a 3% prime rate and 2% markup. It’s important to know what you’re paying for.
- HELOC Interest Rate Cap – Ask the lender what the maximum interest rate is for a certain period or a specific loan term. It may prove to be useful in a volatile interest rate environment.
- Draw Period – Ask how long the draw period is so that you’ll know when you’re allowed to withdraw funds from your home equity line of credit.
- Hidden Fees – Ask about the other fees associated with the HELOC. These include the upfront fees, annual fees, third-party fees, and inactivity fees.
- Repayment Terms – Choosing a shorter repayment term means the interest rate is lower and you get to pay off your loan earlier. However, you’ll have to make higher monthly payments. You need to choose a loan term that best suits your needs.
- Balloon Payment – Some home equity lines of credit require a balloon payment once the draw period ends. You’ll be asked to pay back the outstanding balance in full, which could lead to huge financial problems if you’re unprepared.
How to Use a Home Equity Line of Credit Calculator?
A HELOC calculator can provide you with an estimate of how much you need to pay every month based on the interest rate. Different factors will be considered including your home, value, outstanding mortgage balance, preferred line of credit. Other calculators may also consider other important factors, such as the payoff goal, interest rate, possible yearly rate changes, and annual fees.
List of Best Lenders for HELOC
Here’s a list of best HELOC lenders based on their interest rates, additional fees, and application process.
1. PENFED Credit Union
You can borrow between $25,000 and $500,000 with a maximum variable APR of 4.75%. There’s a $99 annual fee, which can be waived. It has a 10-year draw period and a 20-year repayment period. You have the option to pay the interest-only during the draw period.
2. US Bank
The variable rate ranges between 3.40% and 6.75% APR. HELOC amounts vary from $15,000 to $500,000. The annual fee may reach up to $90. Just like PENFED, US Bank offers a draw period of 10 years and a repayment period of 20 years.
3. Connexus Credit Union
The interest rate of HELOC can be as low as 3.49%. The draw period and repayment periods are set at 15 years, respectively. The loan amount ranges between $5,000 and $200,000.
4. Fifth Third Bank
It offers low variable annual percentage rates that range from 3.75% to 6.35%. There are no closing costs, and the draw and repayment periods are set at 10 years and 20 years, respectively. You can borrow as little as $10,000 to as much as $500,000.
5. Citi
It offers an interest-only draw period and a principal and interest draw period. How much you can borrow will depend on your home’s current value and mortgage. The HELOC APR ranges between 4.09% and 6.99%. You can draw from the line of credit for 10 years and pay it within 20 years.
Conclusion
A home equity line of credit is an excellent option if you’re looking for a flexible type of loan and you’re willing to put up your home as collateral. But before you apply, you need to know what HELOCs are, what purpose they may serve, how to get the best interest rate, factors to consider when looking for HELOCS, and where to find the best deal possible. You need to do your research so that you can make an informed decision in determining if HELOCs are suitable for your financial needs. If it is, you can secure approval between 14 and 28 days and get your funds.
Aidan has been writing about personal finance for over 6 years. Prior to this, he worked as a Corporate Finance Analyst where he specialized in Due Diligence, Company Valuations and more. He is a CFA charterholder.
