A Q&A with Linda Penttila, Director of Home Loan Operations, with contributions from the HELOC Support Team
What is a HELOC?
“HELOC” stands for “home equity line of credit.” Before we talk about how HELOCs work, I’ll define a couple terms.
Equity, or home equity, is the difference between the home’s value and the amount that is paid off. For example, if your home is worth $400,000 and you have $100,000 left to pay off the mortgage, then you have $300,000 in built-up equity.
Lines of credit, or LOCs, provide access to pre-set funds you can borrow, pay back, and borrow again. There are multiple types of LOCs, and one is the HELOC.
A home equity line of credit (HELOC) is a loan that lets you borrow up to a certain amount, using your home as collateral.
A HELOC acts like a credit card in several ways. It has a credit limit, you can borrow against it, pay all or part of the balance down, and borrow again up to the credit limit. Unlike a credit card, you may only borrow from the HELOC for up to 10 years, known as the draw period, as long as you own your home. After the draw period expires, the repayment period begins.
A HELOC can be a solid investment when you use it to improve the value of your home or pay for other worthwhile expenses that could potentially bring you value. You can also use it to cover a variety of expenses ranging from a financial emergency to investments in a potentially profitable enhancement to your small business venture. HELOCS are typically used to fund expenses spread over a period of time, as opposed to one-time expenses. Because you are putting your home on the line as collateral, you should be sure you have a plan to pay it back once the draw period is over.
What’s the difference between a HELOC and a refinance?
Home equity lines of credit (HELOCs) provide an alternative to a cash-out refinance. Both use your home’s equity to provide extra purchasing power. However, they differ in subtle ways.
A HELOC differs from refinancing, primarily in that a HELOC is a separate loan from your mortgage. This means a HELOC features a different term and interest rate from your mortgage, whereas a cash-out refinance is lumped together with the mortgage. The draw period on a HELOC is up to 10 years, but a mortgage refinance can range in term to up to 30 years, depending on the financial institution.
So, which is better? It depends. Most HELOCs provide variable rate loans while cash-out refinancing can be a fixed or adjustable rate. Since mortgage rates fluctuate, there is always a chance that a variable mortgage rate could drop, or rise. It is difficult to predict what the future will bring. The important thing is to make sure you can comfortably accommodate the new loan payment if you refinance, or the additional HELOC payment if you go that route.
I recommend researching the accompanying fees and interest rates to see if a HELOC might be a good option for your financial situation and goals. You can check Vantage West’s current rates, fees, and HELOC types at VantageWest.org/HELOC.
How is a HELOC different than a mortgage?
Both HELOCs and mortgages are loans that use a borrower’s home as collateral. However, there are several primary differences between HELOCS and mortgages.
Borrowers take out HELOCs after they already own, or have equity in, their property and home. In contrast, borrowers get a traditional mortgage to purchase their property and begin building equity in it.
If you have a low rate on your first 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.
What are the benefits of HELOCs for Members?
HELOCs can provide a low-interest credit line that can be helpful for big-ticket purchases or unexpected emergencies, like a kitchen remodel, home repair, new car, wedding, or tuition. Many borrowers also find HELOCs helpful in consolidating debt. A HELOC can help to consolidate debt at a lower interest rate with potential tax benefits, but we recommend you contact a tax advisor to find out for sure about any tax benefits.
A HELOC can offer Members the peace of mind that comes with knowing you can pay for something unexpected without using a high-interest credit card or draining your savings.
Additionally, business owners, commission-based professionals, and seasonal employees sometimes use HELOCs to provide income through their slow seasons.
What should Members consider before applying for a HELOC?
If you’re interested in a HELOC, start by asking yourself some questions:
- Do I have equity in my house?
- Do I have debt from multiple sources that I want to consolidate into one account?
- Do I need liquidity for a specific purpose, like home improvement or extra emergency funds?
- Will I be able to make the monthly payments?
- How will adding a HELOC monthly payment to my budget affect my financial goals?
You can use an online HELOC calculator, like this one from NerdWallet, to help determine your HELOC eligibility and how much you may be able to borrow. These calculators will usually ask for your home’s current value, your mortgage’s outstanding balance, and credit score (Vantage West Primary Members1 can check their credit score 24/7 through “Credit Central by SavvyMoney” in online and mobile banking, for free and without affecting their score).
HELOC lender requirements vary, but here’s what you’ll generally need to get a HELOC (specific guidelines differ depending on which HELOC product you choose):
- A debt-to-income ratio that’s 45% or less
- A credit score of 640 or higher
- A home value that’s at least 15% more than you owe
If Vantage West Members don’t quite meet the lender requirements you just talked about, but a HELOC would be a good choice for them otherwise, what options do we have for them?
We offer a HELOC product called “Credit Builder,” which can be a good option for Members who are building their credit and don’t have a minimum FICO Score of 640 yet. This HELOC gives Members an opportunity to build or rebuild credit while enjoying the benefits of a HELOC we talked about earlier. Here are a few specifics to help Members consider if Credit Builder is right for them:
- Do I have a minimum FICO Score of 600?
- Do I have 30% equity in my home (70% loan-to-value)?
- Am I ready to commit to a 20-year term (five-year draw period, with 15-year repayment – amortized)?
- Have I been a Vantage West Credit Union Member for a minimum of 12 months prior to applying for Credit Builder?
What about real estate investors or Members with investment properties?
We are one of the few financial institutions that currently offers HELOCs on investment properties. The basics work the same as standard HELOCs, just applied to your rental home or investment property, instead of your primary home. There are a few key differences I’ll point out:
- Minimum FICO Score: 700
- Lend up to 30% of your home’s value (70% loan-to-value)
- 20-year term (10-year draw, interest only, with a 10-year repayment – amortized)
- Must be Vantage West Credit Union Member(s) for a minimum of 12 months prior to application date
Is there anything else our readers should know as they consider if a HELOC is right for them?
There’s a complimentary tool available to all Vantage West Members, that I’d recommend everyone takes advantage of. It’s our financial review. Just like checking your credit report on an annual basis, a yearly financial review can help make sure you are on target to achieve your goals like reducing debt, saving for retirement, or putting a down payment on a home.
During a financial review, you’ll go over your short-term and long-term financial goals, and any debts or other factors that may be preventing you from achieving your goals.
When you meet with one of our knowledgeable Financial Representatives for your financial review, this is a great time to talk about HELOCs. Whether you have more questions, are interested in a HELOC, or don’t know if it’s right for you, we can help.
This is a valuable opportunity to see an overview of your financial situation and use this information to decide if a HELOC is right for you.
To schedule a free financial review, visit VantageWest.org/Financial-Review. As you continue pursuing your financial goals, we are here to support you and cheer you on! You can find articles at VantageWest.org/Learn on a variety of subjects, including some of the topics we’ve covered here, and more.