HELOC stands for home equity line of credit, and it is a way banks allow homeowners to borrow against current equity in their homes. A HELOC is just one way a home equity loan may be offered to homeowners. These types of loans tend to have lower interest rates because your home is used as collateral in case you fail to repay.
How HELOCs Work
A home equity line of credit is different from other types of loans because you don’t borrow a lump sum. Instead, a HELOC gives you access to a pre-approved sum of cash that you can borrow from multiple times after you have been approved. A HELOC is similar to having a credit card whose value is secured by the value of your house. HELOCs are a revolving loan that homeowners can borrow against up to their approved credit limit. The size of the loan expands and contracts as it is borrowed against and repaid, much like a credit card.
The main difference between a HELOC and a credit card is that a HELOC has a time limit attached. The draw period is usually an extended period, typically between five to ten years. Monthly payments made during the draw period are to cover interest charges only. Once the draw period of a HELOC ends, the entire balance of the loan becomes due. Whatever is owed at the end of the loan must be paid in one lump sum. HELOCs come with a repayment period of 10 to 20 years where regular payments can be made until the loan is repaid. Most HELOCs function as a second mortgage on homes with an outstanding mortgage balance. However, a HELOC can also be taken out on a home that is fully paid off.
When Should I Use A HELOC?
Most homeowners use HELOCs to make home improvements or to pay for repairs to their home. Using HELOCs in this way makes sense because it adds to the value of your home. However, they aren’t reserved solely for making home improvements. Some reasons why people take out HELOCs include paying for college, starting a business, or consolidating other higher interest debts. You should never use a HELOC as a way to meet your day-to-day spending needs. HELOCs should be used as a way to get access to money that can be used to improve your life, rather than purchase frivolous luxuries.
How Much Can I Borrow?
The amount you can borrow on a HELOC depends on the equity available in your home. Your lender will look at the value of your home and how much is still owed on the current mortgage. For example, a SunTrust HELOC can be around 75% of the home value, minus anything owed on the mortgage. The bank will also look at your income, your current credit rating, and any debts and financial obligations you may have. Banks establish how much they will lend you in your HELOC based on these factors. The interest rate you will be charged depends on your credit score and the current interest rate.