What is a HELOC?
“HELOC” stands for “Home Equity Line of Credit.” A HELOC is a revolving line of credit that allows you to borrow up to a specified amount of money based on the equity you have in your home. You can access the money all at once or in smaller amounts on an as-needed basis. Equity, or Home Equity, is the difference between the home’s current market value and the amount that is owed on the mortgage. For example, if your home’s value is $400,000 and you have $100,000 owed to pay off the mortgage, then you have $300,000 in equity.
What is Loan-To-Value (LTV)
LTV stands for loan-to-value. This is a ratio that is used to determine how much you can borrow. Using our example above and 80% LTV, it is calculated as follows:
Value of $400,000 x 80% = $320,000
The next step in determining how much you can borrow is to subtract any amount you owe on the home:
$320,000 – $100,000 = $220,000
The maximum amount you could borrow if the limit was 80% LTV would be $220,000.
How does a HELOC work?
The revolving line allows you to use credit based on the amount available over a specified timeframe called the draw period. The draw period is generally 10 years, followed by a repayment period of up to 20 years. The HELOC has a variable interest rate which means that the rate and payment may change over time. During the draw period, you’ll only be required to pay interest on the amount you borrow, however, you can repay the outstanding balance owed at any time, making the credit available to use again.
What can I use my HELOC for?
One of the biggest benefits of a HELOC is the flexibility you have for using the line of credit. A HELOC can be used for a variety of purposes such as:
- Home improvement, renovation, upgrades
- Debt consolidation: consolidate outstanding debts with higher interest rates into one monthly payment
- Large purchases
- Emergency fund for unexpected expenses
- Education-related expenses
- General cash management
What are the Benefits of a HELOC?
A HELOC offers benefits that aren’t necessarily available with other types of loans:
- Flexibility with funds. With a HELOC you can access the available credit as you need it and you’ll only pay the principal and interest on what you have borrowed.
- Repayment options. There may be different repayment options, including interest-only or principal and interest. You can repay the principal amount owed at any time within the draw period but aren’t required to do so.
- Closing costs. There are generally minimal-to-no closing costs.
- Potential tax advantages. Be sure to always check with your tax advisor, but there are potential tax advantages to using a HELOC over other types of loans.
- No usage fees. Most lenders don’t charge a fee to access or use the money available.
- Lower interest rates. With a HELOC, you are using the value of your home as collateral, so you are likely to get a lower rate compared to unsecured loan options.
- Home improvements. Using the funds to make upgrades to your home works like an investment, in that the upgrades could increase the value of the home.
- Cash emergency fund. Since you are leveraging your equity and can access money from your HELOC as you need it, you can use the funds in case of unexpected cash emergency.
How is a HELOC different than a mortgage?
Both HELOCs and mortgages are loans that use a borrower’s home as collateral. The primary difference between a HELOC and mortgage is that a mortgage loan is used to purchase the property, whereas a HELOC is used to loan against the equity on a property that is already purchased or owned.
If you have a low rate on your mortgage, rather than doing a cash-out refinance and potentially increasing your rate, it could be beneficial to tap into your equity through a HELOC. Members use this option to get the cash they need while keeping their low first mortgage interest rate.