A house is many Americans’ greatest asset.
Your home can also be a source of money if you have built up enough equity. And while this year has been dominated by headlines about refinancing as a way to unlock that equity, it’s not the only way.
The Home Equity Line of Credit (HELOC) has been harder to come by over the past year, but depending on your circumstances, it may be another option worth considering.
Here is where to start
- What is a HELOC?
- This is how a HELOC works
- Is a HELOC a good idea?
- Qualification for a HELOC
A HELOC can be a way to access cash at lower interest rates than credit cards or personal loans. With prices so low right now, it may be a good time to buy a HELOC – if you can find one.
What is a HELOC?
A HELOC is a revolving line of credit, similar to a credit card. Credit cards are unsecured loans, but a HELOC is secured by your home. This means that if you default on your loan payments, the lender can take your home.
“HELOC is like a credit card for your home in the sense that it is a revolving line of credit and gives you great flexibility to borrow and repay what you need when you need it,” said Greg McBride, chief financial analyst at Bankrate .
Check with banks and credit unions for HELOCs that you already have accounts with as some lenders have stated that they currently only work with existing customers.
This is how a HELOC works
HELOCs typically operate on a 30-year model with a 10-year draw and a 20-year repayment period. During the draw period, you can spend as much as you want up to your credit limit. Then you have the length of the repayment period to pay for what you spent.
HELOCs traditionally have a floating rate, which means that your interest rate fluctuates in relation to a reference rate. Fixed rate HELOCs exist, but they are more commonly found when interest rates rise.
“For example, some lenders offer borrowers the option to set the interest rate on their outstanding balance so that after they accumulate a balance, they won’t be exposed to rising interest rates,” says McBride.
But that’s nothing to worry about right now as interest rates are low and likely not to rise in the next few years, says McBride.
Is a HELOC a good idea?
A HELOC can come in handy when you have large expenses that require cash. Some examples are home renovations, tuition, or debt consolidation.
We contacted five HELOC lenders and those we spoke to say that access to home equity depends on your individual financial situation, but that currently lower interest rates could be an incentive to consider this type of loan.
“Regardless of the market, people should always be careful to access the home equity they have built in their home,” said Tom Parrish, director of product management, retail lending at BMO Harris Bank. “They should think about prudent ways they can use their home equity to make real financial progress.”
Consolidating high yield debt to save interest can help you save money in the long run, but a HELOC can be used for anything. This can be useful if you don’t know exactly what your expenses will be, or if you have ongoing expenses as you only have to pay for what you actually spend (plus interest).
“People who do large home improvement projects where they pay the cost incrementally really turn to HELOC because they only borrow the money when they need it,” says McBride.
In this way, a HELOC is similar to a credit card, but they often have much lower interest rates than a credit card. The HELOC rates are currently around 5%, while the effective annual interest on credit cards averages 16%.
But “don’t get it just in case you get it or buy it just because you can,” says Sidney Divine, a financial planner at Divine Wealth Strategies in Atlanta. “In the long run, it might not be right for you.”
“Using your property as collateral, for example, reduces the equity you have in your home,” said Michelle McLellan, senior vice president of Bank of America. This can be problematic if you decide to move earlier than expected – you’ll have to pay off the HELOC when you sell the property it’s tied to, and it could be more difficult without selling that much equity.
Qualification for a HELOC
Getting a HELOC right now will be tough, especially if you have sub-par credit or don’t have a lot of equity in your home. Many banks have completely stopped accepting HELOC applications, others only work with existing customers.
Because of this, the first port of call may be a bank or credit union that you already have an account with. There are other lenders who will accept applications, but also check local banks and credit unions for location-specific offers.
HELOCs aren’t the only way for homeowners to leverage their equity. Other options are home equity loans and cash out refinancing. And depending on your circumstances, personal loans can also be an option.
Not to be confused with a HELOC, a home equity loan is not a revolving line of credit, but rather a straightforward loan. You receive a lump sum in advance and pay it off over the course of the loan period. However, they have one important similarity: the home equity loan is also a secured loan that counts your home as collateral.
If you do not currently have enough home equity or good credit for a HELOC, you are likely to face similar problems in getting a home loan.
Mortgage refinancing with disbursement
A mortgage refinance with payoff is when you take out a home loan for more than what you owe on a current mortgage and then receive cash for the difference.
“Lots of people are able to get their mortgage refinancing for profit, and that becomes the way they get access to their home equity,” says McBride.
A mortgage refi with payout will still be harder to come by when compared to pre-pandemic times, but not as difficult as a HELOC or a home loan. Refinancing rates have been historically low for months, so a cash-out refinancing could be a good option.
“To be able to cut the interest rate, raise and consolidate some cash, which will free up additional disposable income when things get unsafe,” said Darrin Q. English, senior community development loan officer at Quontic Bank.
A personal loan will get you the money you need upfront and may have lower interest rates than credit cards, although personal loan rates vary dramatically. You can use funds from a personal loan any way you want – a top attraction.
They also require a good credit history for approval and it can be more difficult to find lenders at the moment as the credit market is tight.
A home equity line of credit can be a great way to access funds with lower interest rates than other options like credit cards or personal loans. But it is getting harder to get one now, especially if your credit is not good or you have less home equity.