What Is a HELOC?
A HELOC is not an installment loan, like a home equity loan. Instead, it is a home equity line of credit based on how much equity you have in your home. Your HELOC works a lot like a credit card, with you “freeing up” more room as you make payments. A HELOC is a revolving line of credit with a draw period, which allows you to take money as needed for a certain period of time. After the draw period is over, though, you begin making regular payments.
How Does a HELOC Work?
You can use a HELOC for home improvement and repair projects, debt consolidation, or other large life expenses.
With a HELOC, you can borrow up to a percentage of your home’s value, based on how much you owe. For example, if you have a home worth $250,000, and you still owe $125,000 on your original mortgage, you have $125,000, or 50%, in available home equity. However, a HELOC lender bases your credit amount on your combined loan-to-value (CLTV) ratio. For example, a lender may limit you to 85% CLTV, which includes your HELOC plus your original mortgage. If your home is worth $250,000, 85% equals $212,500. So if you have 50% equity in your home at $125,000, you can only borrow a HELOC up to $87,500—the difference between the total CLTV and the amount of your equity.
The HELOCs draw phase, during which you can withdraw money as needed, up to your available line, is often 10 years. You can make payments during the draw phase, and many HELOC lenders let you choose whether to make interest-only payments or payments that also include the principal.
Most HELOCs come with variable interest rates, though some lenders may offer the option to convert your variable rate to a fixed rate, potentially for a fee.
After the draw phase ends, you have the repayment phase. This is when you can no longer withdraw money, and must make regular payments until the line of credit is paid off. Repayment periods vary per lender, though it is common to have a repayment term of up to 20 years. Keep in mind that if you pay off the line of credit early, you may incur a penalty fee.
Is HELOC Interest Tax Deductible?
Depending on how you use your HELOC, you might be able to deduct some of the interest on your taxes. In order to qualify for a tax deduction, however, the funds must be used on home improvements. You can’t claim a tax deduction for HELOC funds used for other purposes, like debt consolidation or special events.
How to Get a HELOC
Before getting a HELOC, you need to make sure you have available equity in your home. The lender typically checks to see the difference between the value of your home and what you still owe. When you’re ready to get a HELOC, fill out the application with the lender online or in person at a branch. If the lender sees that you have the ability to repay the line of credit and adequate equity in your home, you may be approved for the HELOC and receive the line of credit within just a few days.
It may be possible to get a HELOC through your current mortgage lender, but it may also be smart to research other online lenders to find the best HELOC rates and terms.
HELOC vs. Home Equity Loan
A HELOC is a revolving line of credit that can be accessed as much as needed during the draw period without re-applying. You have a credit limit that’s determined by the equity in your home and how much of the available credit you’ve used. A home equity loan, on the other hand, is an installment loan with a set amount borrowed and a fixed payment schedule.
|HELOC||Home Equity Loan|
|Based on your home’s equity||Based on your home’s equity|
|Revolving line of credit||One lump sum of money|
|Draw period and then repayment period||Repayment period|
|Variable interest rate||Fixed interest rate|
HELOC vs. Refinance
With a refinance, you get a new home loan designed to pay off your old mortgage. This is a completely new mortgage with a new rate and term. It’s also possible to refinance for more than you owe and receive cash for the difference.
|Based on your home’s equity||Replaces your current mortgage|
|Revolving line of credit||Possible to get extra cash by borrowing more than you owe|
|Draw period and then repayment period||Terms may vary, usually up to 30 years|
|Variable interest rate||Fixed and variable interest rates available|
Is a HELOC a Good Idea?
Whether a HELOC is a good idea depends largely on your own goals and finances. If you’re planning to make home improvements and you’re not sure how much they will cost, or if you want access to ongoing financing, a HELOC might work for you.
However, if you just need a set amount of money, want a shorter pay-off period, and don’t anticipate needing to borrow more, a home equity loan might be a better fit.
Consider what you’re using the HELOC for. If you’re paying off debt or taking a vacation, you’re securing the line of credit with your home. If you can’t make payments, you could end up losing your house. Carefully consider your situation before moving forward with a HELOC.
How We Chose the Best HELOC Lenders
We determined our list of the best HELOCs by comparing over 15 different lenders. We looked at fees, repayment terms, and more to find the best HELOC options for homeowners. Our recommendations take into account that borrowers have different financial situations and needs and that not all HELOCs meet those priorities. Not every recommendation is right for every borrower, so consider all your options before applying.
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Connexus Credit Union. “Connexus Membership.” Accessed June 12, 2020.
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