Home equity loans

Home equity loans: borrowing big​

Often referred to as ‘HELOC’, a Home Equity Line of Credit is a way to have access to a substantial amount of money, that is borrowed from your home value. It is a kind of loan that works like a credit card, where you take the money you need and repay the whole sum or part of it monthly or by another period: this process is usually repeated many times until you reach the balance on the initial amount drawn. You can take from it more times or never, although paying interests, and you have just available big liquidity to tap into, and that can be used as an emergency fund.

In the specific, HELOC uses home equity as a fund of credit: your home value minus what is owed on the mortgage, in fact, it is also considered as a second mortgage. It is a secured, risky loan that puts your own house as a guarantee you will repay, otherwise, you will lose it, undergoing foreclosure. So, what is HELOC used for? It is common sense to make some kind of earning out of it (in the very long term), in fact, is typically used for a major renovation, or repair/remodeling, any improvement that can raise the value of the house. Other frequent, possible uses are: for education fees, debt consolidation, down payment of a mortgage, extending the financing of the first mortgage. Of course, you will need a relatively big amount of home equity in order to qualify for a HELOC: this is one of its virtue, you get high cash from what is already yours.

As long as you use it for creating more wealth, it should be just the right option: HELOC may be tax-deductible depending on how it is used. Home refurbishments are ok, while it would not be advisable, for instance, buying a new car or having expensive holidays with it.

 

How does a HELOC work? 

 

There is some calculation: most lenders will estimate up to eighty-five percent of the home value, to which will be subtracted the amount owed for the mortgage. Let’s say you have a home worth $250,000, so 85% is $212,500; your actual balance on mortgage is $110,000, then your HELOC will be $(212,500-110,000)=112,500. All this calculation is based on the determination of LTV, and it is also done for the more traditional HEL. As you can see, that’s a consistent sum. Keep in mind, like every loan on the planet, that it also has interest rates. They are not fixed, except for short periods, but will vary over the entire timeline, following market trends: this can be a big no-no for some borrowers, since percentages on HELOC amounts are financially challenging, being likely that will raise over years. However, rates are pre-set by the lending company, so you can have a good idea of what interests will be like from the beginning; it usually starts with a prime rate plus a markup, which is the variable factor, based upon your credit history: yes, you will be asked about your job, monthly/yearly income and possible existing debts.

The duration of a HELOC is way long: most of the time it lasts as much as the first mortgage, that is to say about thirty years; of this period, you have to distinguish two phases: the draw and the repayment one. Over the draw phase, you will borrow from the credit line as many times (and as much) as you want and pay at least the interests on every withdrawal, but you might also pay the principal, by monthly or quarterly installments. Once this period, which can last up to 10 years has finished, you will have to pay off the whole amount of the loan, being it the principal plus the interests: the repayment period, which can take up to 15 or even 20 years. If you pay off the balance a long time before the expiration, you will be subject to closing costs that can be several hundreds of dollars: that is because the lending company ceases to receive the interests.

Similar to this is a home equity loan, where you get a unique sum (instead of multiple withdrawals) to be repaid periodically, with a rate of interest that doesn’t change over the entire time of the loan.

A home equity line of credit can be given only with a few parameters satisfied: first, your home value must be a minimum of 15% above the owed amount for the mortgage (remember the 85% calculus mentioned above); second, your credit score is very good, let’s say 640 (this depends on the lender), that means also you have a relatively low debt-to-income ratio. Undergoing a HELOC will make the credit score go down, like with any kind of loan, but probably not lower than how would become using a credit card: again, it depends on the company and your financial numbers. The process leading to subscribing to a HELOC is mortgage-alike, so lots of documentation will be required; it would be better to already know how much your home equity is.

When shopping for a HELOC, you must compare at least two lenders (ideally in a marketplace) and watch for a few things: starting offers/promotions, the rates and their expiring period (including APR), origination, and early closure fees. Make sure to choose the lower interest rates, looking at their caps (if there are any) and considering that they will change: during the draw period will be usually at their lowest, while in the repayment phase will tend to rise (also in order to have revenue on the long term, by the side of the lender company).

So, to recap here are some crucial points to remember:

Pros

Cons

One of the main advantages of HELOCs is overall flexibility, which comes at a relatively low interest-rate versus most personal loans, considering the prolonged duration of the loan itself. The main drawback is the secured nature of the loan, followed by the increasing interests that might be overwhelming for some people.

The baseline for deciding to do a HELOC is and must be always your financial stability: if you can’t afford the various fees, potentially including legal and appraisal, and undulating likely-increasing rates, then don’t do it. If you need not as much money, and/or want to finance just fundamental needs, again don’t. On the other side, a HELOC may be a very good option if you have substantial steady incomes, want or need to improve your home, to invest in the education of your sons, or anything that can refine your economics. Good luck with your final choice!