What Is A HELOC and How Does It Work?
A Home Equity Line of Credit (HELOC) is a type of “revolving” credit that is provided by a lender which has a credit limit, a variable interest rate, and which is secured by the equity in your home.
Credit cards are another type of revolving credit, but they tend to come with higher interest rates than HELOCs, which makes them much more expensive when borrowing large amounts of money.
Like credit cards, HELOCs can be used for any type of expense, with typical uses for HELOCs including: home renovations, buying a second home or investment rental property, paying for college tuition, and paying-off high interest debt.
HELOCs are a form of “secured loan,” meaning that lenders require that the borrower put up security or collateral (in this case the borrower’s home) to secure the loan.
While HELOCs are an excellent way to raise funds, keep in mind that because your home is used as collateral, if you default on the loan, the lender has legal recourse.
At Credit Union of Southern California (CU SoCal), we make getting a Home Equity Line of Credit (HELOC) easy.
Call 866.287.6225 today to schedule a no-obligation consultation and learn about our home equity lines of credit, auto loans, personal loans, checking and savings accounts, and other banking products. As a full-service financial institution, we look forward to helping you with all of your banking needs.
Get Started on Your Home Equity Line of Credit (HELOC)
What Is Equity and Why Is It Important?
Each time a homeowner makes their monthly mortgage payment, they are accumulating equity or ownership of the home.
Home equity is the difference between the appraised value of the home and the amount still owed on the mortgage.
For example:
Appraised value $600,000 – Amount owed on mortgage $250,000 = $350,000 Equity
Having equity in your home opens the door to getting secured loans that are based on the home’s equity or use the house as collateral.
A Home Equity Line of Credit (HELOC) allows you to take out a loan based on your home’s equity. Lenders will decide on your loan amount based on the amount of equity you have in the home, and the more equity you have, the more you’ll likely be able to borrow.
HELOC Eligibility Requirements
HELOCs are offered by credit unions, banks, mortgage companies, and some online lenders.
Each lender will have a unique set of qualifying requirements that a borrower must meet to be approved for a loan.
Here are some general HELOC requirements:
- A minimum credit score of 660.
- Proof of income and employment.
- A new appraisal to determine the current value of your home.
- Up to 85% Loan-to-Value (LTV).
One term you’ve likely seen when you applied for your mortgage and will see when applying for a HELOC is Loan-to-Value (LTV).
LTV in a HELOC application refers to a comparison of your mortgage loan balance and the current appraised value of your home. Some lenders will get this ratio based on Combined Loan-to-Value (CLTV) by combining the amount owed on the mortgage and the desired HELOC amount to come up with your total debt.
How much equity do you need for a HELOC? Credit unions and banks will generally lend from 70% to 85% LTV.
For example, lets say a home appraises for $600,000. If the current mortgage is $250,000, and the desired HELOC will be for $150,000, then the total debt owed will be $400,000.
If there are other loan balances, these will be added as well. CLTV is calculated by dividing the sum of the debt $400,000 by the appraised value of the property $600,000. The result is 0.6 or 60% CLTV.
To calculate home equity:
Current appraised value – Mortgage balance = Home Equity
$600,000 - $250,000 = $350,000
For more details, read:
HELOC Requirement
How Much Can You Borrow With A HELOC?
The loan amount that will be offered to you will depend on several factors, including how much equity you have in your home, your credit score, the lender’s maximum loan limit, and a combination of other requirements that may be unique to each lender.
Most HELOCs have a 10-year “draw period” during which money can be borrowed.
If you are approved for a HELOC, you can use as much or as little of the total loan amount as you like.
With that said, be careful: as with paying back any loan, responsible spending is critical, since you will be required to pay back whatever amount you borrow, plus interest.
For more details, read:
How Much HELOC Can I Get.
HELOC Pros and Cons
When borrowing money in the form of a loan, there are always pros and cons to consider. With a HELOC, the main advantage is that as long as you have the equity in your home, the loan is generally easy to get and interest rates are low compared to using a credit card. The primary downside is that your home will be used as collateral, and if you fail to repay the loan, California law generally allows the lender to foreclose on your home to collect the loan.
Pros:
Low APR: While most HELOCs come with an adjustable interest rate, the Annual Percentage Rate (APR) on a HELOC is typically lower than the interest rate charged by credit cards on purchases and cash advances.
Interest May Be Tax Deductible: According to the
IRS, interest paid on home equity loans and lines of credit is only deductible when you use the proceeds to buy, build or substantially improve your home that secures the loan. For example, interest on a home equity loan used to build an addition to an existing home is typically deductible, while interest on the same loan used to pay personal living expenses, such as credit card debts, is not.
Get more information from the IRS.
Borrow Only What You Need: Because this loan is a line of credit, you can take out money as you need it, and you will only pay interest on the amount you borrow.
Flexible Repayment Options: All HELOCS have a “Draw Period” (typically 10 years) and a “repayment period” (typically up to 20 years). During the draw period, you can borrow as much of the funds as you need. Depending on the lender, payments made during the draw period may be “interest only,” meaning you aren’t repaying the loan principal. Some lenders will allow payments toward principal during the draw period. Be sure to ask the lender about repayment terms.
Raise Your Credit Score: Making on-time loan payments will boost your credit score. Adding a HELOC to your credit mix can boost your
FICO score in two ways: by adding to your credit history (which accounts for 35% of your credit score), and adding to your credit mix (which accounts for 10% of your credit score).
Few Restrictions: You can use the money any way you’d like!
Cons:
Your Home Will Be Used As Collateral: If you default on the loan, the lender can take possession of the house through a foreclosure and you could lose your home. Failure to make on-time monthly payments will hurt your credit score.
Variable Interest Rate: HELOCs often come with a low promotional rate as well as a variable rate that can increase over time. A variable interest rate means the payment owed will be different each month. If your financial situation worsens during the loan period, you could end up owing more than you are able to pay.
Overspending: Because the money is available, many people will borrow from it freely and run the risk of using more funds than originally planned. The draw period’s interest-only payments make repayment appear manageable, but eventually the principal amount will need to be paid back.
Reduced Equity In Your Home: Using your home as collateral means you have less equity. This could affect your ability to get approved for other loans while you have an open HELOC.
HELOC Alternatives
If a HELOC isn’t right for you, consider these other loan options:
Home Equity Loan: Home equity loans typically feature a fixed interest rate and the money is provided as a lump sum. Once you receive the funds repayment begins immediately and monthly payments are based on the full loan amount. For more details read HELOC vs. Home Equity Loan" [LINK once it's published https://www.cusocal.org/blog/heloc-vs-home-equity-loan]
Cash-Out Refinance: With mortgage interest rates very low, refinancing your current mortgage to a new mortgage loan could help you lower your monthly payments. Getting cash-out means borrowing more than what you owe on your current mortgage and get a cash disbursement of the extra funds at closing. You can use the cash any way you choose.
Personal Loans: Credit unions and banks offer a wide variety of
secured and unsecured personal loans, to meet a wide variety of borrowing needs. You’ll find variable and fixed rate
personal loan options.
Is a HELOC a Good Idea?
When shopping for a loan, always speak to several lenders and make sure you understand the terms, fees, interest rate, and repayment requirements of the loan you are looking at.
Deciding whether a HELOC is right for you is a serious matter, as it involves using your house as collateral. If you will be using the funds to increase the value of your home, a HELOC could make sense. If you need money to take a vacation or make luxury item purchases, then an
unsecured personal loan would be a safer option.
CU SoCal offers an interest-only HELOC, so you pay only the interest due each month, giving you the flexibility to keep payments low during the 10-year draw period of your loan. We offer the choice of either a lump-sum loan or a revolving credit line that can be used over and over again. View our
HELOC webpage here.
Other great HELOC features include:
- Access up to 80% of your home's equity.
- No points.
- No appraisal fees for single unit loans.
- No annual fee.
- No closing costs.
- Loan limit up to $250,000.
Why Savvy Consumers Choose CU SoCal
For over 60 years, CU SoCal has been providing financial services, including HELOCs, car loans, personal loans, mortgages, credit cards, and other banking products, to those who live, work, worship, or attend school in Orange County, Los Angeles County, Riverside County, and San Bernardino County.
Please give us a call today at 866.287.6225 today to schedule a no-obligation consultation with one of our HELOC experts.
Get Started on Your Home Equity Line of Credit (HELOC)