A home equity line of credit (HELOC) allows you to borrow against your home's value. It offers borrowers flexibility, letting them draw and repay funds similarly to a credit card but with the advantage of typically lower interest rates in home equity or mortgage loans. If you have equity in your home, think about how a HELOC might benefit you.

Understanding Home Equity Lines of Credit

Often called a HELOC, a home equity line of credit is a type of second mortgage on the value of your home. Your current mortgage is your first mortgage, but if your home is worth more than what you owe on the mortgage, you may be able to tap into that equity. To determine your equity, first, find out what the home is worth if sold today. Then, subtract the current mortgage balance from it. The difference is your equity, and you can borrow some of that by establishing a home equity line of credit.

Typically, these loans are not meant for day-to-day expenses since they come with closing costs and other fees. Instead, they are often best suited for more significant expenses you may have occasionally. There's no restriction on their use, another reason these loans benefit borrowers.

Overview of Home Equity Lines of Credit

There are a few factors to consider when it comes to HELOCs. The first is to understand your home's actual value. It is not the original value of your mortgage or what you believe your property to be worth. Instead, it is the current appraised value of the property. You will likely need to appraise the home to determine the value.

Most lenders do not allow you to obtain loans for the total value of your home, but generally, 80 to 90% of the home's value. That means that between your mortgage on the home right now and the new home equity line of credit, you may not surpass more than 90% of the home's value.

Interest rates are often lower on HELOC than on unsecured credit cards. However, they may be higher than you expect for a mortgage.

Also note that many HELOCs are in place for a limited time, such as 5- or 10-year terms. During that period, you can use the available balance on your HELOC and make payments on it. Once you pay off a portion of the HELOC, you can borrow that amount again, much like a credit card works.

The lender may provide a credit limit for you to use during that period. Other loans are more flexible in the amount you can borrow based on the equity you have in the home.

Applying for a Home Equity Line of Credit

Like applying for any home loan or mortgage, you must apply for the loan and meet the lender's qualifications. That typically includes meeting the lender's requirements for:

• Credit score
• Income
• History of making on-time payments on your existing loan (you may need to be in good standing with your existing loan)
• Steady employment
• References

The application process usually requires a home appraisal to determine its value. You will likely pay a fee for this appraisal and an additional fee for the loan application.

Numerous types of lenders offer HELOCs, including traditional banks, credit unions, and specialized lenders. You do not have to use the same lender that holds your current mortgage loan.

Pros and Cons of Home Equity Lines of Credit

Numerous factors play a role in whether or not you should choose a HELOC. Consider some of the pros and cons.

Pros of HELOCs:

• They give you borrowing power at an interest typically lower than traditional credit cards.
• Most HELOCs are more accessible than larger, unsecured personal loans.
• You can use the funds for any needs you have. There are no restrictions on use.
• Sometimes, the interest on a HELOC is tax deductible, which can be an excellent way to lower your taxes.

Cons of HELOCs:

• There are fees to pay, including closing costs and, in some cases, annual fees, which add to the overall borrowing cost of these loans.
• Typically, you must have a debt-to-income ratio of 40% or less and a credit score of 620 or higher to qualify for these loans.
• You are borrowing against your home's value, which means your home is being used as collateral to obtain these loans.

Best Practices When Considering a Home Equity Line of Credit

If you're thinking about HELOCs, there are a few things to keep in mind:

• Be sure to speak to the lender about the amount you can borrow.
• Typically, this is not more than 80 to 90 percent of the value of your home at today's rate.
• Always consider the value of HELOCs based on your needs. You could use them to help with down payments, debt consolidation, or other terms and conditions, but defaulting on them could put your home at risk.
• Shop around for the best loan terms and conditions. Many lenders can offer a range of benefits to you.

Takeaways

HELOCs are a valuable tool for those who want borrowing power. You can use them as often as you need to, borrowing from and paying them back over time. With careful consideration of your options, they can prove to be a more valuable opportunity than using credit cards or other borrowing options.