A HELOC is a home equity line of credit that allows you to tap on your home equity for cash. It is a second mortgage that provides you with access to funds using the value of your home. Whether you need to redo your kitchen or you want to give a complete makeover to your garden – you can use the funds as you please.
In this article:
- What is a HELOC?
- How does it work?
- Does a HELOC impact your credit score?
- How to qualify for a HELOC?
- What are the alternatives to a HELOC?
What is a HELOC?
The amount that you can borrow depends on your equity. Your equity will be the amount subtracted from your home’s current value by the amount that you owe on your primary mortgage. Even if you have paid off your mortgage and own your home outright, you are still eligible for a HELOC.
The repayment period may go up to 30 years. You can choose the repayment period according to the amount that you borrow and your monthly earnings and outgoings. This financing method allows flexibility to borrowers in terms of taking out money, using and repaying it.
How does it work?
HELOC is a revolving type of credit. It functions like a credit card. When you apply for a HELOC, the lender will evaluate your equity and set a borrowing limit. It’s up to you how you use it. You can use the entire amount or you can use a portion of it. The interest will be levied on the amount that you use.
Generally, a lender allows you to borrow 60-80% of your home’s equity. The amount that you can borrow doesn’t only depend on the equity. There is a range of factors such as your credit score, employment status, income and expenses that are taken into consideration while assessing your loan application.
A HELOC is different from a home equity loan. With a home equity loan, you are supposed to pay for the loan amount that you take out in monthly instalments. However, with a HELOC, you will have to pay interest on the portion of the money that you actually use.
Does a HELOC impact your credit score?
Every financing option does have an impact on your credit score. The lender will conduct a credit check on your report and that will certainly take off a few points from your score. Also, how you manage the repayments of this loan will impact your credit score.
If you make the payments on time, your credit score will get a boost. But if you fail to make the payments on time and in full, it will adversely affect your score. There will be a drop in your score and it may further worsen if the lender decides to take legal help to recover the money you owe to them.
How to qualify for a HELOC?
Every lender has different lending criteria. When you apply for a HELOC, lenders will conduct a property search to calculate the value of your home. Moreover, a credit check will also be performed to determine your creditworthiness and affordability. With a better credit score, you are more likely to get loans that have favourable terms.
Another important factor that will help you qualify for a HELOC is your debt-to-income ratio. Also, a thorough search for your financial relationship will be carried out. They may want to know how well you manage your finances, for example, any bankruptcies or County Court Judgements or foreclosures.
Before you apply for a HELOC or any financial product, review your credit report. If you find any issues in your report, contact any of three Credit Reference Agencies (CRAs) namely Equifax, Experian, and TransUnion. Raise a flag and get the report fixed as it plays a dominant role in the assessment of your application.
What are the alternatives to a HELOC?
A HELOC is not the only option that you can consider while searching for financing possibilities. Depending on your requirement there are a lot of alternatives that you may take into account. Here’s a list of options that you can use:
- Cash-out Refinance: Cash-out refinance is a method of borrowing money against the value of your home. This is ideal for those who have sufficient equity in their homes. However, you’ll have to fully refinance your mortgage rather than borrowing a separate loan. But, this will allow you to switch to an offer with better terms and a larger sum of money. Now, you can use the funds from the refinanced loan to pay towards the original mortgage. Plus, you’re free to use the rest of the proceeds as per your convenience. Refinancing can prove to be a good way to consolidate debts or making major purchases. Although, you may end up paying higher interest on your mortgage. Before resorting to this option, check if your lender charges a fee on premature repayment.
- Personal Loans: This option comes in handy when you neither want to use your home as collateral nor want to tap into your home equity. Personal loans are unsecured, so you won’t have to risk any of your assets to secure a loan. The interest rate charged on a personal loan will be subject to your creditworthiness. Once your loan gets approved, you’ll receive the proceeds in a lump sum. You’ll be required to make fixed monthly payments towards the loan to repay it. The tenure for personal loans tends to be smaller than that of HELOC, so you may be better off borrowing a smaller amount.
- Home Equity Loans: Home equity loans are perceived to be similar to HELOC since they both involve borrowing against the equity in your home. The one differentiating factor, in this case, is the fact that Home Equity loans are instalment loans, whereas HELOC is a revolving line of credit. If you can work out the amount of money you need, then home equity loan can be a better option. This is because it offers more security over the entire loan term, with a fixed interest rate. However, this might translate into a higher interest rate than that of a HELOC.
When you have substantial equity in your home, you have more options for borrowing money using HELOC. Although, you will need to secure your home against the loan, which puts your biggest asset at risk. Therefore, you must work out a repayment plan for the loan. Determine the amount of money you need, pan out the term over which you plan to borrow and incorporate the monthly repayments in your budget. Always assess the costs, risks and benefits involved in the loan you’re planning to take. Regardless of the credit option you choose, ensure that you fulfil the loan’s obligations by repaying on time.
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