What Is a HELOC Loan?
When you’re paying off your mortgage, you might find yourself in need of extra capital. Whether you’re looking to consolidate high-interest debt or need to make unexpected repairs to your home, a HELOC loan may be the answer.
“HELOC” stands for “home equity line of credit.” It’s a secured credit line where your home is your collateral. The Low Rate Co. can help you secure a HELOC loan at the lowest possible rate. But exactly what is a HELOC loan, and should you get one?
What Is a HELOC Loan?
A HELOC loan is a line of credit that lets you borrow against the equity you have in your home. Much like a credit card, your credit line is still available to you (for a while) when you repay your balance.
Your home equity refers to the portion of your home you’ve already paid for (via a down payment or mortgage payments). You can easily find your home equity by subtracting the amount you owe from the home’s total value.
However, a HELOC is somewhat different from other types of credit in that it has a draw period and a repayment period.
You can withdraw funds from the credit line as needed during the draw period, which usually lasts five to 10 years. You don’t have to pay down the balance you owe during this period, but you do need to pay any accumulated interest.
Once the draw period has ended, you enter the repayment period. This is when you can no longer draw funds and must begin paying down your balance.
Repayment periods usually last 10 to 20 years. Usually, you’ll pay what you owe in monthly installments, much like you would with a traditional loan.
So why go with a HELOC over another loan type? For one thing, HELOC rates tend to be lower than rates on credit cards and other types of loans. And depending on your circumstances, your interest may be tax-deductible.
Is a HELOC the Same as a Home Equity Loan?
HELOCs and home equity loans are both commonly referred to as “second mortgages.” That’s because they let you borrow against your home, often while you’re still making payments on your initial mortgage.
However, HELOCs and home equity loans aren’t exactly the same. With a HELOC, you have access to a credit line. That means you can make withdrawals as needed, but you don’t need to borrow the money all at once.
A home equity loan works like most other loans: you get the amount you borrowed in a one-time lump sum. You then start paying it off with fixed monthly payments.
How Is It Different from a Cash-Out Refinance?
With a cash-out refinance, you’re not getting a second mortgage but replacing your existing mortgage with another one.
The “cash-out” part refers to the amount of the new loan available after you pay off your old mortgage. If your mortgage has a variable rate, a cash-out refinance can sometimes save you thousands of dollars in interest over time.
How Do You Qualify for a HELOC Loan?
Different HELOC lenders will often have slightly different loan terms. But any lender will take a close look at your home, income, credit, and other factors. Here are a few key factors to look at before you apply.
Amount of Equity in Your Home
Some lenders will require you to have a certain amount of equity in your home. If you’ve just finished signing your mortgage papers, you likely won’t qualify for a HELOC just yet.
Since your home is the collateral for a HELOC, your lender will want to make sure they have an idea of your home’s value. Sometimes, a lender may want to appraise your home before offering you a loan.
Your Credit, Debt, and Income
Before offering a HELOC, a lender will also want to assess you as a borrower. Most lenders will look at the following factors:
- Your credit score and credit history
- Your debt-to-income ratio
- The stability of your income
Some lenders have set requirements. For instance, you might need a credit score of 640 and a debt-to-income ratio of less than 50%. Other lenders take a holistic look at your individual circumstances.
Where and How Can You Apply?
If a HELOC sounds right for you, you might be ready to apply. But first, you need to identify potential HELOC lenders. Banks and credit unions often finance HELOCS. To apply, you’ll usually need to gather relevant materials and visit a branch in person.
If you’d rather apply from the comfort of your home, you can complete Low Rate Co.’s online application process in minutes.
You’ll need to make sure you have some basic information available before applying, including:
- The amount you’re seeking and what you want to use it for
- Your personal information and Social Security number
- Employment status and income verification
- Information on your home (purchase date and amount, mortgage payment amount, amount left on mortgage, property taxes, etc.)
Some lenders may request additional information, which they’ll ask for when you apply.
How Much Can You Borrow?
Before you even apply, you can get a general sense of how much you might be approved for. With most HELOCS, you can borrow 80%–85% of your equity in your home.
However, keep in mind that the factors mentioned above (like your home’s value and your credit score) can influence the lender’s decision.
Variable vs. Fixed Interest Rates
Depending on the HELOC options your lender gives you, you may have the option to choose between a variable-rate HELOC and a fixed-rate one.
Variable-rate HELOCS are a gamble. The amount of interest you owe each month fluctuates based on indexes for current rates. If there’s a trend of declining interest rates, you might end up paying less over time with a variable rate. But if interest rates start to rise, you’ll be left paying more.
If you want something more stable, a fixed-rate HELOC is probably your best bet. With this type of loan, your rate is locked in from the beginning.
If interest rates go down, you’ll be stuck with your old rate. But if they start to rise, you’ll be protected.
Calculating HELOC Interest Rates
One of the most important parts of getting a HELOC loan is ensuring that you don’t pay an exorbitant amount of interest. The good news is that you can determine HELOC rates using a simple calculation:
Outstanding HELOC balance x Daily periodic rate = interest per day
The outstanding HELOC balance is the amount on the loan you haven’t yet paid. Your daily periodic rate is 1/365 of your annual percentage rate (APR). It divides up your total interest to show you how much you pay per day.
Of course, if you’d rather not do the math, you can also use a handy online HELOC calculator.
If you aren’t sure what your APR is, it’s easy enough to find out. Your monthly statement will include your HELOC interest rates. Alternatively, your bank can tell you what your APR is.
What About Additional Fees?
Understanding HELOC rates and how they work is important, but it’s also important to be mindful of extra fees that may come with your line of credit. Here are a few fees you might need to budget for:
- Application/origination fee
- Appraisal fee
- Notary fee
- Credit report fee
- Document preparation fee
Think those fees sound excessive? So do we. That’s why we cut out the middlemen so you can get a great rate without paying a commission and many other fees.
How Do You Withdraw Money?
You technically can withdraw as much money as you can as soon as your draw period starts. However, that’s not a great idea.
You immediately start paying interest on any money you withdraw, so make sure to only take out funds as needed. As mentioned, most draw periods are five to 10 years, so spreading out your withdrawals may lead to significant savings.
You don’t have to start repaying what you’ve borrowed during the draw period. However, you do need to pay interest on any funds you withdraw.
What about actually accessing money? How you get the funds depends on your bank.
In some cases, the bank may be able to do a same-day transfer to your bank account. In others, the bank may write you a check or require you to visit in person to withdraw money. Some companies even offer credit cards linked to your HELOC.
How Do You Repay Money?
Every HELOC has a repayment period when you can no longer withdraw funds. However, if you choose to, you can pay down your balance while you’re still in the draw period. If you do this, it’s like paying down a credit card: you can continue to use the credit line.
Once you enter the repayment period, you no longer have access to the credit line, and you’ll need to repay anything you owe. Most of the time, you can do this with monthly payments. Repayment periods are usually 10–20 years, so your monthly payments will likely be manageable.
It’s critically important to repay your HELOC on time. If you’re late on payments or miss them altogether, you’re likely to see a dip in your credit score. But more importantly, your home is your collateral — if you don’t pay, your lender may foreclose on it.
It’s very rare for HELOCs to have an early closure fee or an early repayment penalty. If you aren’t sure if yours does, clarify with your lender.
Can You Use a HELOC to Pay off a Mortgage?
If your HELOC grants you access to sufficient funds, it may be wise to use it to pay off the remainder of your mortgage. After all, HELOC interest rates tend to be very low, and you may find that yours is actually lower than your mortgage interest rate.
Once your HELOC enters the repayment period, you’ll still need to make monthly payments, but your interest savings can be substantial.
What Is a HELOC Loan Good For?
Only you can decide whether a HELOC loan is the best option for you. However, there are a few instances when taking out a HELOC might be a good idea:
During Home Renovations
Renovating your home increases its value over time. If you’re gradually doing renovations, a HELOC can allow you to draw funds as you need them. Sometimes, your HELOC interest will even be tax-deductible if you use it to pay for home improvements.
When Consolidating Debt
If you feel confident in your ability to pay off your debt, it may save you money to take out a HELOC to consolidate credit cards and other types of high-interest debt. Just remember that your house is collateral, so you risk losing it if you can’t repay.
When You Need an Emergency Fund
If you’ve exhausted all other savings and find yourself in need of money for an emergency expense, taking out a HELOC as an emergency fund is sometimes a good idea. Of course, you should be certain you can repay a HELOC before taking one out.
When Purchasing a Vehicle
If you’re financially stable and are confident you can pay it back, you might want to take out a HELOC loan to finance the purchase of a new vehicle. That’s because HELOC interest rates can sometimes be lower than interest rates on a car loan. Just check the rates of each before making a decision!
Want the Best Possible Rate on Your HELOC Loan?
Whether you need a HELOC loan or a mortgage, Low Rate Co. is committed to getting you the best possible rate.
We operate on a zero-percent commission model, meaning we’ve done away with the middleman. And thanks to new technology, we can make the financing process stress-free and simple, without high rates or outrageous fees.
You can apply online 24 hours a day, seven days a week. And if you have any questions, our knowledgeable team can talk with you and help you find a solution.
Reach out to us today — a better financial situation is only a conversation away.