What is a HELOC?

HELOC stands for “home equity line of credit.” Your equity is the difference between how much your home is worth and how much you have left to pay it off. Let’s look at an example: If your home is worth $300,000 and you still have $100,000 to pay before the house is yours, then you have $200,000 of equity ($300,000 minus $100,000). Your lender can let you open a home equity line of credit (HELOC) based on a certain percentage of the $200,000, which you can use however you want. It’s relatively easy for some homeowners to get a HELOC because it presents a low risk for lenders. In a HELOC transaction, your house serves as the collateral.

How does a HELOC work?

Now that we’ve covered the basics of a HELOC, you might be wondering exactly how a HELOC works. The short answer: different HELOCs work different ways.

First lien and second lien HELOCs allow you to access the equity in your home. Specifically, the second lien HELOC allows you to keep your current, low rate first mortgage while accessing your home’s equity.

For example, when you apply and qualify for a Homebridge HELOC, you are given a range of how much you can borrow. Once you decide on the amount you want, a line of credit is opened, and funds are disbursed.

You can elect to have payments made directly to your credit card company and other lenders, have the funds deposited directly into your bank account, or both!

For the first five years after you receive your funds, you’ll make “interest-only” payments. These are lower than traditional “principal-and-interest” payments, which can make it a little easier on your monthly budget.

After the first five years, you enter the repayment period. During this time, you won’t be able to borrow money from your HELOC. Instead, you’ll be required to start paying back your loan. This includes the loan itself (the principal) plus interest.

Are there requirements for a HELOC?

To get a HELOC, you must have a certain amount of equity in your home. The amount can differ among lenders, but you’re usually expected to have at least 20% equity.

Do you know your credit score? Generally, you’ll have an easier time qualifying for a HELOC if your credit score is 640 or higher.

You also don’t want to carry too much debt, such as high credit card bills. If a large portion of your salary goes toward debt payments, a lender might consider a HELOC too big of an obligation. (That said, you may also be able to use your new HELOC to pay down your high-interest bills — improving your debt-to-income ratio.) *

Your home will need an appraisal too. Many lenders use an automated valuation model (AVM), which means an appraiser does not need to visit your home to determine its value. Rather, this model compares the values of properties similar to yours.

Lenders will want you to have a reliable source of income and a good job record. They’ll also examine your history of repaying loans. For example, they’ll want to see if you made your car loan payments on time.

* “Paying off unsecured debt with a HELOC makes it secured.”

How to use a HELOC

Although you can use a HELOC however you like, it’s often recommended you only use it for major or necessary expenses. A new roof for your home is a good example. A luxury vacation, on the other hand, is probably not.

Families sometimes use HELOCs to pay for the ever-increasing cost of a college education. Another option is to use a HELOC as an investment or financial opportunity.

Many older people have discovered that retiring too soon can rapidly drain savings, forcing them to find a job, whether part time or full. A HELOC can support retirement, allowing people to enjoy their freedom rather than look for employment.

How much HELOC can I get?

When applying for a loan such as a HELOC, it’s natural to wonder how much money you can borrow from your home. Let’s look at the basic calculation:
Most lenders offer up to 80% of your home’s value minus your mortgage balance. So, let’s start by multiplying your home’s value by 0.8.

Using the previous example: If your home is worth $300,000, multiply that by 0.8 to get $240,000.

Now subtract your mortgage balance, the amount you have left to pay on the house. Let’s say that’s $100,000.

$240,000 minus $100,000 equals $140,000, the HELOC amount a lender might offer.

Access your home equity

You’ve spent years building equity in your home. If you need the money, why not use it? Take advantage of your hard work. But make sure your plans involve life-changing improvements, such as eliminating debt, rather than temporary pleasures like a holiday cruise.

Before you apply for a loan, take time to review your finances. For example, get a free credit report to see what your credit score is.

After reviewing your credit report, you might decide to pay down some of your debt. Plus, you may need to correct errors on your report before applying.