A home equity line of credit, also known as a HELOC, is an open-end revolving line of credit in which the borrower uses their home equity as collateral. HELOC lenders create a lien against the borrower’s home until the full amount is paid off, similar to a first mortgage.
HELOC loans are often used to finance major expenses such as home improvement, medical expenses, or college tuition fees. Borrowers may draw funds at any time, provided they don’t exceed the approved credit limit. Borrowers only pay principal and interest on the funds drawn. Like a home equity loan, a HELOC may involve closing fees at the start of the loan.
Technically speaking, a HELOC can be used for any large expense. This could include consolidating credit card debt or other debts; funding an unexpected bill, such as an unexpected medical procedure; financing a home improvement or refurbishment; purchasing a vehicle; or funding a child’s college tuition.
Generally, a HELOC is best used for anything that improves your financial position, such as paying off debts or boosting your home’s value. Let’s say you’re struggling to keep up with payments to three separate credit card providers, all of which are charging high interest. With a HELOC, you could replace those high-interest debts with a single, lower-interest repayment to your home equity lender.
The best HELOC lenders let you use your funds for any purpose, but this shouldn’t be interpreted as a license to be reckless. When you secure a loan or line of credit with your property, that gives the lender permission to foreclose the property if you default on the loan. Therefore, when taking a HELOC or similar loan, always take caution against over-extending.
The basic requirement of a HELOC is that you own your home. At most, lenders permit homeowners to borrow up to a combined loan-to-value (CLTV) ratio of 90% (although some credit unions may allow 100% CLTV). In other words, a lender will not approve you for a HELOC if it means your home equity drops below 10% of your home’s current appraised value. Generally, banks offering HELOC loans will only accept borrowers with owner-occupied properties, although in some cases they may accept rental or investment properties as collateral.
Aside from CLTV, all the other minimum requirements of mortgage or loan eligibility apply. You will need to be a U.S. citizen or resident aged 18 years or more. The lender will run a credit check, which will affect your credit score. And you will need to provide certain financial documentation, although less than for a traditional mortgage application.
HELOC rates are almost always adjustable, meaning your rate is adjusted up or down at various intervals during your loan term. There is such a thing as a fixed rate HELOC, but you’ll need to search hard to find one.
The best HELOC rates today start at below 3% while the worst rates go as high as 20%. To get the best HELOC rates, you’ll need to have strong credit, strong income, and low LTV. To find the absolute lowest rates on the market, we recommend selecting a few of the best HELOC lenders and then applying for prequalified rate quotes from each one.
Home Equity Loan
A home equity loan is like any other type of closed-end loan in that the lender pays the borrower a lump sum which the borrower must repay within an agreed payment term. Closed-end home equity loans usually come with a fixed interest rate, giving the borrower the predictability of fixed monthly payments for the life of the loan.
Cash-out refinance
A cash-out refinance is when the new mortgage is greater in value than what you owe on the old loan, allowing you to cash out the difference. A cash-out refi usually involves a lower rate than a HELOC but higher closing costs and fees. Therefore, if you’re going for a smaller amount, a HELOC is better. If you’re going for a larger amount, you may want to consider a cash-out refi. The exact decision depends on your home equity and your loan amount and on how much you’re able to afford in monthly payments.
Home equity investment
A new type of HELOC alternative gaining in popularity is a home investment, where a financing company invests in your home in exchange for a share of your home’s future sale price or market value. There are a number of different versions of this on the market, but the principle is more or less the same in all cases: you get the cash upfront, and the financing company shares in your home’s appreciation when you sell.
Personal loan
An unsecured personal loan is the easiest way to get your hands on quick cash because it doesn’t involve any collateral and the process is very quick, with funds by the next business day. Personal loans beat HELOCs and home equity loans for convenience, but beware: the interest rates are usually much higher. While the average HELOC rate in 2022 is 3-4%, the average personal loan rate is 10-20%, which can send your monthly payment soaring.
Maximum LTV
Combined loan-to-value (CLTV) is as important a factor in refinancing as a down payment is when purchasing. If you only have 20% equity in your home, then you won’t qualify for HELOC lenders with a maximum 80% CLTV. Therefore, always compare lender maximum LTVs to find one that suits you.
APR
A HELOC might not be like your original loan, but you still need to repay every dollar you draw and therefore the interest rate is still the most important factor in determining your repayments. Always compare a few lenders to find the best HELOC rates for your financial and credit profile.
Terms
HELOCs usually have a 10 year draw period and 15 to 30 years in which to repay the drawn amount. The best repayment term for you depends on how much you can afford in monthly payments. The shorter the term, the higher your monthly payments but the less you’ll pay in interest over the life of the loan. The longer the term, the lower your monthly payments but the more you’ll pay your lender in the long run.
Ease of application
Gone are the days when you had to walk into a physical branch to apply for a HELOC. These days, banks offering HELOC usually accept applications online, sometimes through a fully automated online mortgage platform and other times with phone assistance from a loan agent. If convenience is important to you, then keep an eye out for digital-friendly HELOC lenders.
