Your Guide to HELOC Loans

HELOC (Home Equity Line of Credit) Loans Trade Equity for Cash

A home equity line of credit, known as a HELOC, allows homeowners to fund all sorts of projects and investments by using the equity you’ve put into the home so far. While this inexpensive way to borrow has its own rules and restrictions, for the most part a HELOC is an effective way to leverage what’s been contributed to the principal so far.

Making the most of a HELOC is easier when you know how it all works, so we’ll do a deep dive into what HELOCS are, how they work, and what risks you might take when using one.

What Is a HELOC?

A HELOC is a form of line of credit, a form of borrowing that lets you draw money up to agreed upon amounts, and only pay interest on any funds actually withdrawn. LoCs require collateral in case someone can’t make the payments, and with a HELOC, the collateral is the house itself.

How much you can get from a HELOC is partly based on how much equity you have, which is the percentage of the home you own outright. If your home is valued at $350,000 and there’s $200,000 still on the current mortgage, you would have $150,000 in equity. A HELOC would let you tap into that $150,000 for all sorts of things, as long as you can pay back whatever is spent plus interest. While similar, it’s not the same as a home equity loan or cash-out refinancing. All three options turn your home’s equity into accessible funding with the home as collateral, but HELOCS have lower upfront costs, and are ideal when everything is ongoing or uncertain.

A key benefit of a HELOC is that you don’t need to spend up to the credit limit. You can borrow as much or as little of it as you need to fund your projects, and you’ll only be on the hook for what was used. In fact, lenders won’t even let you borrow the full amount of your equity. They’ll leave behind a certain percentage as a cushion in case the area’s home prices change or they need to sell the house themselves.

How HELOCs Work: Draw and Repayment Periods, Combined Loan-to-Value

HELOCs are built around draw periods and repayment periods. During the draw period, you can borrow the HELOC funds as needed, and only pay interest. This period usually lasts about 10 years, giving recipients plenty of time to complete their projects without having to worry about making payments for what’s already been completed. That being said, you can make those payments if you want to.

After the draw period, the repayment period kicks in. New borrowing stops, and you’ll need to pay everything you spent as part of the HELOC plus any accumulated interest. It turns into a regular loan, and must be paid off within the agreed upon time, which is usually between 10 and 20 years. Some HELOCS skip the repayment period and require the entire balance upfront once the draw period is over, known as a balloon payment. Even after you pay off the balance, the line of credit remains open and attached to your home’s title. Some lenders even charge a fee to close the line of credit within the first several years.

You should also know that lenders can adjust your line of credit or even freeze it entirely before the draw period ends if the home’s value has dropped or the lender is aware that your finances have gotten worse.

How Much Can You Borrow with a HELOC?

Remember how lenders won’t let you borrow 100% of your equity, and hold onto a percentage as a cushion? That upper limit needs to be set, and they use what’s called combined loan-to-value. This figure compares everything you’d owe on the home, including the HELOC’s new line of credit, against what the house is currently worth.

In general, that maxes at between 80% to 90%, with most HELOCs CLTV hovering in the middle around 85%. Using the same example from earlier:

• Your home is worth $350,000, so 85% of that is $297,500
  • You still owe $200,000 on your mortgage
    • $297,500 – $200,000 = a maximum HELOC of $97,500. That $52,500 remaining is the lender’s cushion

The full line of credit from the HELOC counts towards the CLTV, even if you don’t plan on using the full amount. Other debts attached the home also count, such as a second mortgage, other home equity loans, or unpaid liens.

For the lower limit, or how you qualify for the HELOC to begin with, lenders use things like:

• Your credit score: Higher credit scores earn higher CLTV limits with smaller margins tacked on.
• Your debt-to-income ratio: Many lenders look for this to be below a certain percentage.
• How the property is used: Second homes get lower limits, and rentals don’t usually qualify for HELOCS in the first place.
• What type of property it is: Condos, apartment buildings, and other multi-family housing usually have extra restrictions.

Using a HELOC, and What Happens to the Equity and Debt

You might think that HELOC funds have to be used for renovating the home used as collateral, but HELOCs are much, much more versatile. While home repairs or improvements are common reasons to draw from a HELOC, you can also pay off debt, invest in education or other real estate, and even set it aside for an emergency fund.

If a lender does establish limits, it’s usually around more volatile/uncertain uses of the money, such as buying stocks or placing bets. They may also restrict commercial use, but some HELOCS can be used to start or invest in businesses. Finally, you can’t tell the bank you’re planning on using funds one way, only to turn around and use them in another, which is a form of fraud.

While drawing from the HELOC subtracts from your total equity, depending on what you use the money for, you can get some of the equity back. For example, investing in home renovations can raise the home’s value, and subsequently restore some of the equity. Since most projects recover less than what they cost, don’t assume making improvements will pay for themselves.

Paying off debt is another common use for a HELOC thanks to the lower interest rate, but getting that rate also means attaching the debt to the house. If you were still somehow unable to pay off that debt, it could now cost you your home. All other purchases, like a new car or investing in college classes, just lower the equity by the equivalent amount.

A HELOC Is a Versatile Tool, but Is it Right for You?

By tapping into your home’s equity, a HELOC frees up funds you can use to make improvements that bolster value and help recoup some of that equity back. But HELOCs can also be used to pay off debt, pursue an education, and much more. If your income is steady, and you’re confident it’s going to stay that way, the risks are manageable.

SoldFast frequently works with sellers who’ve made renovations to their homes using HELOC funds, and we may be interested in your property too! When you schedule an appointment, we’ll review all your possible options and walk you through how it works so you the most from your house, even if you end up working with someone else.

To get started, give us a call at 855-276-5332 today!