HELOC: Understanding Home Equity Line of Credit and Its Benefits

Are you looking to refinance your house, but you don’t know which option suits you best? You have come to the right place. When you decide to refinance your property, you take out a second mortgage on it. You can use this second mortgage to improve the quality of your property by either adding an extra room or updating the exterior of your house, these changes increase the value of your property. As homeowners, you also have the added perk of building equity, which makes acquiring a second mortgage easier.

One of the best options you can choose is the Home Equity Line of Credit (HELOC). If you have enough equity build on your house then you are eligible to apply for HELOC.

What is the Home Equity Line of Credit (HELOC)?

HELOC is a type of second mortgage that is taken out against the equity you have in your house. It is an open-end credit, which means you can draw the allotted amount over time instead of receiving it as a whole. This is good because it helps with paying for costs which might arise over time. It provides you, the borrowers, flexibility.

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How exactly does HELOC work?

Before you decide to pawn in your house as collateral for HELOC, you need to understand how exactly does it work and what you are getting yourself into. HELOC is a credit-based mortgage option therefore it allows you access to a certain value of your house through a line of credit. You have access to this credit and you can use it whenever you want, sort of like a credit card. Just make sure you don’t exceed the set credit limit.

Characteristics of HELOC:

• Limited Credit: Most lenders will underwrite the assigned amount when you get a second mortgage. They allow you access to about 85% of your home’s value. Your equity in the house is the primary factor that determines the credit you will receive.
• Draw Period: The draw period is essentially the timeframe in which you can get credit against your house. You can borrow as much funds you want in this time. It is typically around 5 to 10 years.
• Repayment Period: The repayment period starts once the draw period comes to an end. In this timeframe you must repay the original borrowed sum along with the interest that accumulated over time. The repayment period lasts for about 10 to 20 years.
• Interest Rates: Majority of the HELOC typically have variable interest rates that tend to fluctuate with the market. However, some lenders tend have a fixed-rate HELOC option as well. Make sure you check the terms and conditions before applying.
• Interest-Only Repayments: Initially during the draw period, you can only pay back the interest only payments. Once the draw period has ended you can pay back the principal amount along with any remaining interest.

Can You Use HELOC for Other Purposes?  

Yes, you can use the HELOC to pay for emergencies as well it’s not limited to house improvements. You can use the sum to pay for medical bills, education expenses and even for your business. All you have to do is be a responsible borrower and repay it on time. Another thing to keep in mind is that if you won’t be able to deduct the interest on the loan unless the purchase goes towards home improvements.

Requirements for Applying for a HELOC:

HELOC requirements tend to vary from lender to lender, but the general requirements are almost the same, which are as follows:

• Debt-to-Income Ratio: When you are applying for a second mortgage, you still need to have a low debt-to-income ratio. A DTI of 40% or less is always favorable.
• Credit Score: You will need to have at least 620 credit score when applying for HELOC. Some lenders are willing to go lower if you have good DTI ratio and higher equity.
• Repayment History: Lenders might ask for your repayment history typically if you had large debts or loans in the past. Your repayment history shows that you are capable of making repayments on time which is a reassuring fact for lenders.
• Equity: You should have at least 15% equity when you apply for a HELOC.
• Proper Documents: Before you head over to a lender to apply for a HELOC ensure that you have all the necessary documents in order such as proof of income, assets, employment record, pay stubs and tax returns. The documents help lenders assess if you are capable of sustaining an additional debt. So, make sure these are in order before applying.
• Find a Good Lender: If you are looking for a lender, it is a good idea to start with your current mortgage lender or bank. You can also look online or visit your local lenders. You should gather information and compare prequalification process of each lender. This ensures that you get the best terms and conditions without effecting your credit.

Advantages and Disadvantages of HELOC:

Just like any other loan option, HELOC has its fair share of advantages and disadvantages. Let’s take a closer look at them to ascertain if it’s a good fit for you or not.

Advantages of HELOC:

• Easy Access to Funds: If you are in urgent need of cash, then HELOC is a good option. As most lends tend to respond to HELOC applications in a matter of hours. Therefore, you will have access of the funds and flexibility to draw these funds whenever you want.
• Low Interest Rates: HELOC tend to have lower interest rates when compared to other credit options such as credit cards. The interest rates of HELOC are comparatively better than unsecured loan options.
• Tax Benefits: If you are taking out a HELOC loan specifying for home improvement projects then you might be eligible for tax deductions on the interest payments. You will have to discuss this with your tax advisor.
• Cancel Within 3 Days: If you have a change of mind or don’t think that HELOC is a good choice for you, especially if you have served your primary residence as collateral for HELOC. No need to worry. You can cancel the HELOC within 3 days after closing. It is your fundamental right and is known as the right of rescission.

Disadvantages of HELOC:

Understanding the disadvantages of HELOC can work in your favor as this is a secured debt. In secured debt you put your house as collateral. Therefore, you have to responsible and repay on time.

• Risk of Foreclosure: As HELOC is borrowed on the basis that you keep your house as collateral, which means if you miss to repay the initial amount along with the interest your house will be foreclosed by the lender. Failure to repay could end up in losing your property.
• Fluctuation in Interest Rates: The interest rates for HELOC are variable, as discussed above. Therefore, it can lead to higher repayments over time.
• Reduced Equity: The basis of HELOC is that you are borrowing against your equity in the house, therefore with each withdrawal you lose your share in the property. This can cause financial as well as future borrowing capacity.

Contact Us to Better a Better Assessment!

Applying for a HELOC can be quite a tricky business. It is a great option if you are strapped for cash and are currently financially stable, but you need expert guidance to help you navigate the ups and downs of a HELOC loan. Our licensed mortgage lenders at Dream Home Mortgage can offer you all the information you need, and we can even help you figure out if it’s the right option for you. You will be guided through the process under the stewardship of our senior consultant, Mr. Hussein Panjwani.

So, what are you waiting for? Book your free consultation today!