You may have heard the term thrown around before, but you may still be wondering, what exactly is a HELOC, and is it right for me? If you’re a homeowner looking for a lower-interest loan option, then the answer to that second question may just be yes.
HELOC stands for Home Equity Line of Credit, which is a revolving line of credit secured by your home that you can use to pay for large expenses or consolidate higher-interest rate debt on other loans, such as student loans or credit cards.
Secured Loan Vs Unsecured Loan
Unlike a credit card or personal loan, which does not have collateral behind it and is thus considered an “unsecured” loan, a “secured” loan is backed by an asset – for example, a car if you are getting an auto loan, or in the case of a HELOC, your home.
But What’s a Home Equity Loan, Then?
Similar to a HELOC, a home equity loan is also secured by the equity in your home, but the key difference is that it gives you a fixed amount of money in one lump sum. A HELOC, on the other hand, allows you to borrow as little or as much money as you need through a certain draw period (typically 10 years). During this time, you are only required to pay interest, and will then begin the repayment period once that time is up. Both home equity loans and HELOCs usually offer lower interest rates than many other types of loans and maybe tax-deductible (Check with your tax advisor first).
Your home’s equity is calculated using your home’s current value minus any liens against it, such as your mortgage. For example, if your home is worth $500,000 and you have $100,000 left on your mortgage, which is your only lien, you have $400,000 in home equity. Depending on your financial history, lenders may let you borrow up to 80-85% of home equity.
Borrowers who may not know exactly how much they’ll need or when they’ll need it may be more likely to consider a HELOC. Most HELOC loans have variable interest rates, which means your monthly payments will vary depending on whether rates go up or down. However, you may be able to find a promotional rate for the first 12 months or so.
Many choose a HELOC to pay for schooling, as they usually have lower rates than education loans. Another popular way to use a HELOC is for home repairs and improvements – essentially using the value in your home to create more value.
How to apply for a HELOC
You can choose to apply for a HELOC or home equity loan with the same financial institution you used to open your mortgage or a different one. Make sure to shop around for APRs (Annual Percentage Rates), but keep in mind that APRs between home equity loans and HELOCs are calculated differently. For a home equity loan, the APR is calculated using the interest rate, points, and other fees, such as closing costs. The APR for a HELOC is calculated by the index used to determine the HELOC rate. This is generally the Prime Rate, as published by the Wall Street Journal. Both HELOCs and home equity loans carry closing costs and fees, which may range anywhere from 2% to 5% of the loan. Some financial institutions may waive these fees upfront, but they could be included in your final payment – make sure to ask about this. You may also be charged an annual fee on your HELOC, which is payable in addition to any interest due and is payable even if the line is never used. You can use our handy calculator to estimate your approximate cost.
It is always a good idea to check your credit score before applying for any type of loan. The higher your credit score, the better the rates you may qualify for. Service Credit Union offers members free access to FICO® scores, and you can also get three free credit reports per year from each reporting agency (Equifax, Experian, and TransUnion.)
Next, you’ll want to check your available equity with the formula mentioned earlier: Add the amount you want to borrow to the amount you already owe on your home and make sure the total isn’t more than your home’s value.
Think about how much you currently pay on debts such as your mortgage or student loans, and decide what you can afford in monthly home equity or HELOC payments.
If you’re ready to learn more and possibly apply for a HELOC or home equity loan, our real estate experts are here to help. Visit https://servicecu.org/borrow/home-equity-loans/ or call 800-619-6575 to learn more.