What is a HELOC?
In its simplest form, a HELOC works somewhat like a credit card. You can borrow money up to a certain credit limit set by your lender and then pay back the borrowed amounts along with interest. This option can offer more flexibility — you can even withdraw and make payments on a daily or weekly basis, if necessary.
What determines a HELOC’s credit limit?
A HELOC’s credit limit depends on a number of factors, including your credit and unpaid debts, but it’s determined largely by the market value of your home and the amount you owe on your mortgage.
For instance, if you own a home valued at $700,000 and still owe $480,000 on your first mortgage, then your home equity stands at $220,000. Lenders typically limit the amount you can borrow to no more than 80% of the appraised value of your home minus what you owe on your mortgage.
In this case, the maximum amount you’d be able to borrow is $80,000. Here’s how that’s calculated, assuming there are no other liens on your home.
Home’s market value: $700,000
80% of home’s value: $560,000
Minus mortgage balance: $560,000 - $480,000
Potential line of credit: $80,000
Benefits of a HELOC?
A HELOC is an open mortgage and can be paid back at any time with no pre-payment penalty. There is no cost to use a HELOC unless you have a balance on it. The minimum payments each month are interest only. Ie. $25,000 HELOC balance, Prime +.50% interest rate currently is 6.45%. $25,000 X .0645 / 12 months = $134.38/mth. This is compared to a payment of $152/mth with a traditional amortized mortgage.
What’s the length of a HELOC term?
The length is tied into your mortgage term. If you renew with your lender then the HELOC can be renewed as well. If you change lenders at any time, you can look to have another HELOC attached to your property.
What does it cost to set up a HELOC?
Setting up your HELOC could cost you hundreds of dollars as typically an appraisal and a legal component come into play. Some mortgages are already set up for a HELOC and there might not be a cost. It is on a case by case basis depending on your lender.
How to use a HELOC
There are numerous ways to take advantage of a HELOC.
1)Transferring higher interest credit balances. HELOCs will have a very low-interest rate compared to unsecured credit(credit cards, LOC, loans, etc). You can still make the same monthly payment you were making but more will be applied to the principle if the debt is on your HELOC. This means the debt is paid off quicker.
2) Emergency fund for loss of job, health reasons, etc.
3) Repairs or maintenance on your home.
4) Renovations on your home.
5) Buy investments, property, etc.
What’s next?
Before you decide to take out a HELOC, consider what you’ll need it for. If you’re planning to use a HELOC for home improvements, investments, debt consolidation, etc, it could make more sense to do an actual refinance which allows you to reamortize your mortgage. We wouldn't know which option is the best until we run the numbers for you.
If you’d like me to outline all of your options, please let me know.
