When you have equity in your home (the amount it’s worth minus how much you owe), you can leverage it to pay for big expenses like college tuition or home renovations. You can also use it to consolidate high-interest debts.
One way to get cash from the equity in your home is with a home equity line of credit, also known as a HELOC. There’s a lot to unpack with HELOCs and they’re often easily misunderstood. So, let’s start with definitions of important terms you’ll want to know when applying for a HELOC.
GLOSSARY OF HELOC TERMS
Equity: The difference between what your house is worth and what you owe on it
Interest: The percentage rate lenders charge you for using their money. The higher the percentage, the more you pay
Annual Percentage Rate (APR): The cost of a loan shown as a percentage rate. It includes both the interest rate on the loan and the costs of taking out the loan. APRs are the best way to compare loans!
Closing Costs: All the “other” costs to be paid when taking out a HELOC like fees for credit reports, land survey, appraisal, title search, title insurance, and attorney fees–just to name a few!
Like credit cards, HELOCs offer you a line of credit up to a certain dollar amount. You then repay the funds slowly over time. Typically, lenders will let you borrow anywhere from 80 to 95 percent of your home’s equity.
At the start of your loan, there’s a draw period, which is the length of time your line of credit will stay open so that you can “draw” funds from it. During this period, you might only be required to pay interest on the amount borrowed. Draw times typically average 10 years.
After the draw period is over, you enter the repayment period. At this point, your credit line is closed (meaning you can no longer access the money) and you now must start paying off the principal (the entire loan itself) plus interest. Therefore, your required monthly payments will be much higher than during the draw period, so you need to be prepared for that change.
Another very important factor of a HELOC is that to get one, you must use your home as collateral. This means that if you don’t make your payments, the lender has the right to take your home from you as a way of collecting on the funds they loaned.
HELOCs charge a variable interest rate, which means the interest you pay each month will vary based on changes in the market. Therefore, you won’t be able to budget for a fixed, predictable interest payment every month because it will fluctuate.
At the beginning of a HELOC (the draw period), you typically make interest-only payments, which helps keep your costs low. But remember, once the draw period ends and the repayment phase begins, you’ll start making much bigger monthly payments.
Also keep in mind that all HELOC payments are in addition to your existing mortgage payment. They don’t replace your current mortgage loan.
Be sure to ask the lender about any closing fees associated with your HELOC, because sometimes they’re rolled into the cost of your loan and other times they’re tacked on at the closing. That can make a big difference for your budget!
SMART TIPS BEFORE YOU APPLY FOR A HELOC
Take the time to research options from various financial institutions and lenders. Get quotes from at least three different lenders to compare their rates, fees, and terms. You want to get the best loan possible, so putting the time in upfront will be worth your while.
Know Your Credit History
You should know your credit score before applying because it can help you get a better rate, or you might need to work on raising the number. You can request a free credit report from any of the three credit bureaus: Experian, TransUnion, and Equifax. They all allow you to have one full report every year without any change to your credit score.
If you need to improve your score, try to pay off some existing debt or make extra mortgage payments to increase equity in your home. Doing either of these will bump up your credit score and make your application more attractive to lenders.