As far as financial instruments go, HELOCs are about as straightforward as they come. Fundamentally, they’re a useful tool for borrowing against the equity you’ve already built up in your home—without tapping into resources like 401ks or savings accounts you’ve worked to build.
As HELOC stands for home equity line of credit, a simple concept becomes even simpler when you break it into its two components:
Home equity: The difference between the current value of your home and whatever’s left on your mortgage. For example, if your home is worth $500,000, and you have $250,000 left to pay on your mortgage, your home equity is $250,000.
Line of credit: A near-instant, always-on fund that can be tapped into as needed, rather than a predetermined loan that obligates you to receive all the money at once. Credit cards are the simplest example of a line of credit, and plainly speaking, HELOCs are a close relative.
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How does a HELOC work?
After applying for a HELOC, the process will look quite similar to any loan. After assessing your circumstances and creditworthiness, the lender will typically determine what limits they’re willing to set.
Many HELOC lenders may extend a line of credit that tops out somewhere near the same amount of equity you’ve accrued. In the above example, a healthy borrower with $250,000 in equity may receive a credit limit up to $225,000. That’s $225,000 to draw from over the course of a preset draw period, typically only paying interest on the amount borrowed.
After the draw period ends—often a 5- or 10-year term—the borrower enters the repayment phase. During this time, you’ll be expected to repay both principle and interest. And because HELOCs often come with variable interest rates, it’s important to consider how your payments will jump during the repayment phase, and plan accordingly.
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Why apply for a HELOC?
For well-disciplined borrowers, a HELOC is often an easy way to find lower interest rates and more flexible terms when it comes to home renovations. If you already have a large amount of equity built in your house, your HELOC could allow you access to greater funds in a shorter amount of time than a traditional loan.
On the flip side, consider the fact that in the case of a HELOC, your house is the collateral. Missed payments may risk foreclosure, and you may forgo other borrowing opportunities if all your equity is pinned to a home equity line of credit.
Ultimately, a HELOC is like any other financial tool: Properly assessed with your financial plans, it can provide a valuable opportunity for home repairs or larger remodeling jobs. If you’re interested in a HELOC, talk with us today about your plans, and we can work with you to find the rate, terms and flexibility you need to make it a reality.
