What is a Home Equity Line of Credit (HELOC) and How Do They Work? What is a Home Equity Line of Credit (HELOC) and How Do They Work?
A Home Equity Line of Credit, also known as a HELOC, is a lending solution that allows homeowners to use the equity in their home to obtain a line of credit that can be used to achieve a variety of homeownership and financial goals. HELOCs are commonly used to fund home improvements but can be used for a variety of purposes. Below, we'll explore how HELOCs work and what they can help you achieve as a homeowner.
What is Home Equity?
Before we dive into how HELOCs work, let's take a moment to outline what home equity is. Essentially, it's what portion of your home you own. To dig a little bit deeper, home equity is the current value of your home minus the outstanding amount you owe on your mortgage. For instance, if you buy a home for $500,000 and put 20% down with the remaining balance of $400,000 covered by a mortgage, you'll be starting off with $100,000 worth of home equity.
Your home equity will increase over time as you make payments toward the principal on your mortgage and if the value of your home increases (conversely your equity can decrease if your property value goes down). You can use the equity you've built in your home to secure a HELOC or Home Equity Loan.
How Do Home Equity Lines of Credit (HELOCs) Work?
A HELOC allows you to borrow against the available equity you've built in your home with your house used as collateral for the line of credit. A HELOC provides access to funds and functions similar to a credit card -- you can make withdrawals from your line of credit up to your approved limit. You can borrow against a HELOC as much or as little as you need to throughout the draw period before the repayment period begins (more on that below). Borrowing limits vary by lender, but many lenders allow homeowners to borrow up to 85% of the value of their home (minus the amount owed on their mortgage) with a HELOC. Since the collateral for a HELOC is your home, you'll generally receive a more competitive interest rate than other types of loans.
How Do HELOC Repayments Work?
HELOC repayments differ from traditional mortgages in that instead of fixed monthly payments, HELOC repayment happens in two phases -- the draw period and the repayment period. Below, we'll explore each of these repayment periods in greater detail.
What is the Draw Period?
During the draw period, which can last between five and ten years depending on your lender and loan terms, you can borrow funds from your line of credit up to your credit limit and make interest-only payments (principal payments being optional during the draw period).
What is the Repayment Period?
Once the draw period ends, the repayment period begins. This period lasts between 10 and 20 years and requires that you make principal and interest payments until the total amount borrowed is paid off. You can no longer borrow against the credit line during the repayment period.
Do HELOCs Have a Fixed Rate or Variable Interest Rate?
The answer is that it depends on your lender, but we'll explain how both options work. If you have a HELOC with a variable interest rate, your rate can change on a monthly basis. A variable rate is generally calculated from an index and a margin. The index is a financial indicator used by banks to set rates on consumer loan products (many banks, including Leader Bank, use the Wall Street Journal's Prime Rate). This means that your HELOC interest rate is subject to change as the index moves up or down. The other part of a variable HELOC interest rate is the margin, which is constant throughout the life of the loan and is added on top of the index to calculate the final interest rate.
Some lenders offer HELOCs where a portion of the outstanding variable-rate balance can be converted to a fixed rate. The benefit of a fixed-rate HELOC is that your interest rate and payments are predictable each month and insulated from potential rate increases.
The great thing about Leader Bank HELOCs is that they feature a fixed Annual Percentage Rate for the initial term of the loan (either six months or three years), followed by a rate based on the current Prime index for the life of the loan.
What Can a HELOC Be Used For?
A HELOC can be put to use to achieve a range of homeownership and financial goals:
- Repairs or Renovations: If you have an older home that is desperately in need of renovations or if you have a home improvement project that you've putting off, then a HELOC is a great way to tap into the equity in your home to accomplish your homeownership goals.
- Consolidate Debt: If you've accumulated high-interest rate debt -- from your mortgage, student loans, credit cards, or a medical procedure -- a HELOC can help you consolidate it.
- Pay For Educational Expenses: Looking to finance college expenses for a family member? A HELOC can offer flexibility and a competitive interest rate.
- Retirement: A HELOC can help you meet a variety of cash needs related to retirement including making home accessibility upgrades, making a down payment on a second home, or mitigating unexpected stock market downturns.
- Emergency Fund: As we mentioned above, you can draw on a HELOC as needed. This makes them a great option for dealing with unexpected cash needs.
- Personal Purchases or Investments: Looking to purchase an investment property, vacation home, finance a wedding, or take a once-in-a-lifetime trip? A HELOC can help make it happen!
How to Get Started With a HELOC
You can start gaining flexible access to funds by tapping into your home's equity with a Leader Bank HELOC! You can get a customized rate quote today!
