Homes with a mortgage gained $26,300 in equity in the final quarter of 2020, marking the highest average gain since 2013, according to CoreLogic data. With many Americans seeing their home's value go up, now is a good time to explore home-equity lines of credit (HELOCs).
But first, a quick refresher on home equity. Home equity is what your home is worth, minus what you owe on the property's mortgage. So, if your home’s value is $340,000 and you have $225,000 left to pay on the mortgage, that means your home equity is $115,000. (As a note, most lenders do not lend up to 100%, so the amount you might be able to borrow could be less than the total home equity.)
What is a Home Equity Line of Credit (HELOC)?
HELOCs are a line of credit that lets you use your home as collateral. They are not to be confused with a traditional home equity loan, which involves borrowing a one-time lump sum to be repaid by a set date. Rather, HELOCs allow you to draw up to a pre-approved maximum amount during the draw period.
What You Can Use HELOCs
Let’s look at why you might use a HELOC. Mostly, homeowners use HELOCs to finance large purchases, like home renovations. Or they use them to consolidate high-interest rate debts, for children’s college education, or to refinance their home mortgage with a low or no closing cost and fixed-rate lock option (FRL).
How Lenders Will Work Out Your Credit Limit
Different lenders will use different formulas to work out your credit limit. But it’s typically influenced by your home's equity, credit history, any current debts and your income.
Understand the Benefits of HELOCs
Let’s take a closer look at what makes HELOCs a useful financial tool for homeowners. Here are some of the pros of HELOCs:
- Borrow just what you need. With HELOCs, you can borrow funds only when you need them. This can be a more flexible option than personal loans and the home equity loans mentioned earlier, where lump sums are your only option. If you borrow less with a HELOC, you may also be able to make manageable monthly repayments.
- Get low annual percentage rates (APR). HELOCs can be useful for making ongoing purchases and consolidating outstanding debt. Many HELOCs come with lower interest rates than credit cards.
- Get higher credit limits. HELOCs are somewhat similar to credit cards, but they typically cover much more significant amounts. Where your typical credit card might have a limit of $5,000, a HELOC might be up to $1,000,000.
- Boost your credit score. Make on-time and consistent payments on your HELOC to show sound financial habits. This can make healthy credit scores even healthier.
- Refinance your mortgage in days. Refinance your mortgage in days. Many Home Equity Lines of Credit give you the option to borrow at a variable interest rate or to lock in a fixed rate. For example, you can draw up to your maximum line amount, select a term up to 30 years and fix your interest rate for a $100 fee to ‘lock’. When interest rates change and you want to refinance that draw you will pay a $100 unlock fee and move the funds to the variable portion of the line. If fixed rates are low you can relock for $100.
Above all, HELOCs give you the flexibility to draw on your credit line whenever you need it. Discover PNC's Home Equity Line of Credit Options.
Understand the Drawbacks of HELOCs
HELOCs should only be used for essential borrowing. Here are some of the drawbacks to understand:
- You risk losing your home. You’re using your home as collateral for a HELOC. Yes, this might lower your interest rate, but if you fail to make the repayments, you risk your home being foreclosed.
- Variable rate changes. HELOCs typically have variable interest rates. That means they change with the underlying index used by your lender. A rise of even a few percentage points can add hundreds of dollars to what you pay in a year.
- Tax deductibility laws have changed. HELOC interest was 100 percent tax-deductible up until 2017. Nowadays, you can only deduct the HELOC interest you have paid for building or improving the house that was used to secure the line of credit. Consult your tax advisor regarding tax deductibility.
Why You Should Shop Around for HELOCs
Many financial institutions base their HELOC rate on The Wall Street Journal prime rate. This is the key lending rate banks give to customers with positive credit scores. The rate is currently at 3.25 percent and many lenders add a margin to this rate, so keep an eye out for terms like ‘prime plus 1 percent' to spot this margin. Not every HELOC product is the same, and it’s important to shop around before you apply.
Are HELOCs Right for You?
You can usually only draw from your HELOC for a fixed time frame called the Draw Period, and many lenders will allow you to renew it if you need your HELOC for longer. You will likely have two options if you still owe on your plan when the loan matures. You can:
- refinance or renew into a new line with the existing balance
- enter into repayment to convert the balance into an installment loan with a 30-year maturity.
If you do choose to apply for a HELOC, make sure you have a clear plan to repay it. Your minimum monthly payments will likely include a mix of principal and interest. With some plans, you’ll only have to repay the interest during your draw period. After that, you will be responsible to pay the interest plus a portion of the principal amount.
Here's the bottom line: HELOCs are a useful finance source for savvy homeowners who want to complete important financial projects, such as renovations or further education. And with house values on the rise, now's the time to give HELOCs a closer look.