One of the biggest financial benefits of owning a home is being able to use your home’s equity to achieve other financial goals. This equity can build up gradually over time as you make mortgage payments to reduce the principal amount owed on your home.
At the same time, increasing real estate prices may raise the appraised value of your home, which becomes equity you can access through home loan products. Research suggests that homeowners have seen a dramatic rise in home equity in recent years. According to one report, U.S. homeowners enjoyed an average increase in equity of $55,300 since the fourth quarter of 2020.
This rise in equity also reflects a rise in purchasing power when that equity is accessed through home loan products. Many homeowners are eager to use their equity to afford major purchases and investments, which can range from home improvement projects to funding a small business venture.
While there are several ways to use your home’s equity to afford large purchases or create financial relief, a home equity line of credit (HELOC) is a popular — and valuable — lending option available through many banks, credit unions and other financial institutions.
If you’re interested in tapping your home’s equity to achieve other goals, read on for an introduction to HELOCs, including what to expect when applying for this line of credit.
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What is a home equity line of credit, and how does it work?
A home equity line of credit is a credit line opened based on the equity you have built in your home. This line of credit is used similar to how a borrower uses the credit available to them through a credit card. Although it is made available to homeowners — with a limit placed on how much borrowers can charge to the account — you only pay interest on the amount you use. Once you pay off your balance, you stop paying interest, and the full balance remains available for future needs.
HELOCs function differently from a home equity loan in that they remain open to be reused for future needs. With a home equity loan, you borrow money, repay your debt, and can’t borrow again without applying for a new loan. With a HELOC, the line of credit you opened becomes available as soon as debt is paid off, providing a revolving credit option tied to your home’s equity.
What can you use a HELOC for?
Once you’re approved for a HELOC, you can use those funds however you want.
This doesn’t mean that all HELOC borrowing is created equal. Financial experts recommend using a HELOC to cover long-term expenses such as home renovations, college tuition, medical expenses or even high-interest debt. Using a HELOC to finance a vacation or make large discretionary purchases, on the other hand, may be a far more risky financial endeavor.
Despite the varying levels of risk involved in various spending decisions, borrowers can use funds from a HELOC however they like. Similarly, you can also choose your own repayment amount and repayment schedule based on what works best with your monthly budget as long as you understand the implications this repayment plan will have on your interest charges.
What should you expect during the process of getting a HELOC?
Compared to the application process for a conventional home mortgage, the HELOC application is typically much faster and easier for borrowers to complete.
In most cases, a HELOC approval takes 30-45 days between the initial application and the final closing — although borrowers should always check with their lender to confirm the estimated approval timeline. Regardless of how long it takes to secure a HELOC, borrowers can expect to go through the following steps:
- Fill out an initial application. This application, which may be filled out online, collects your basic personal and financial information and identifies the type of financing you are seeking.
- Provide proof of income and other documentation. As with any other home loan product, you will need to provide documentation that verifies your income. This may include pay stubs, bank statements, letters from an employer, tax returns and other documentation. Consult with your lender to determine which documents you need to provide, and be prepared to supply your lender with additional information as needed during HELOC application processing.
- Undergo a home appraisal. Before you can borrow money against the equity you’ve built up in your home, your lender will want to confirm the value of your home through an appraisal. A third-party appraiser will be sent to your home to inspect it and submit an appraised value to the lender. This appraised value will be used to determine how much equity you are able to borrow from your home.
- Complete closing. Once the home has been appraised and the HELOC has been approved, you will sign contracts as part of your HELOC closing. Shortly after closing is completed, you will have access to your line of credit and be able to withdraw funds.
How much can you borrow from a HELOC?
Since a HELOC is based on the amount of equity you have in your home, how much you can borrow is subject to this amount. Most lenders will let you borrow up to 80% of the value of your home.
If you want to borrow beyond this 80% equity mark, you may be subject to a higher interest rate. Some lenders may also set limits for how much equity you can borrow, even at an elevated interest rate.
How do you pay back a HELOC?
Just as HELOCs offer flexibility in how much you borrow and when, borrowers also have flexibility in how they pay back this borrowed amount.
Every HELOC comes with a predetermined draw period, which is the amount of time you can withdraw funds from the account. During this period, you can withdraw funds and pay off your balance at your discretion as long as you make a minimum payment.
At the end of this draw period — typically 10 years — you will then have another period of time to fully repay the amount owed. In most cases, this can be up to 20 years, although each lender may have its own rules for this.
What are some alternatives to a HELOC?
Interested in exploring your options outside of a HELOC? Whether you’re looking for different borrowing terms or simply conducting your due diligence, it never hurts to understand the different borrowing options that share similar traits or purposes as a HELOC.
Here’s a look at possible financing options instead of a HELOC:
- Home equity loan: This is a second loan taken out against your home, where you’re borrowing against your home’s equity in addition to your mortgage. It comes with a fixed or adjustable interest rate and a set repayment term, and it lacks the flexibility for you to reuse this product when you want to access your home’s equity in the future.
- Cash-out refinance: If you can lower your mortgage interest rate by refinancing your existing mortgage, you can “cash out” additional equity in your home. While refinancing comes with higher fees than other lending options, a cash-out refinance can help you improve your primary mortgage and reap long-term savings on interest.
- Personal loans: Similar to a home equity loan, personal loans only account for your income and ability to repay the loan, saving you from being dependent on — or limited by — the equity in your home.
- Credit cards: While the interest rates charged by credit cards make them cost-prohibitive as a long-term financing option, these revolving accounts offer long-term flexibility that consumers may seek from a HELOC.
When you want access to affordable, flexible financing, a home equity line of credit is a great way for homeowners to leverage one financial achievement to create additional opportunities in the future. And by keeping a HELOC open, you can enjoy the peace of mind offered by this credit line even after you’ve repaid the initial amount you borrowed.
Ready to apply for a HELOC and find out how much you’re able to receive in a line of credit? Your local credit union can offer HELOCs at competitive rates to give you full control over your borrowing decisions.