How Does a Home Equity Line of Credit Work?

Home Equity Line of Credit

In the following article, we’ll be exploring the question, how does a home equity line of credit work? The acronym HELOC stands for a home equity line of credit. These financial instruments can be useful to homeowners who don’t have emergency funds to handle key purchases and obligations.

We’ll also be guiding you in some of the best (and worst) ways to use one. Let’s begin!

What Is a Home Equity Line of Credit?

A home equity line of credit allows you to borrow what you need instead of the max amount of your equity. It’s particularly helpful for things like home repairs when you’re not quite sure what the cost will be but know you’ll need some extra cash. It acts like a credit card instead of a personal loan.

What You Should Know About Home Equity Lines of Credit

Home equity lines of credit often come with favorable interest rates compared to personal loans, and they are way more affordable than the standard consumer credit card. You only pay interest on the amount you use rather than the full amount of the credit line.

Careful not to default should you ever need to use one, however. Doing so could place your home in danger of foreclosure.

Can I Get a Home Equity Line of Credit With Bad Credit?

Yes, it’s possible to get a line of credit just as it’s possible to get a home equity loan because credit history and score are not the only factors that lenders will use when determining eligibility. They also look at the loan-to-value ratio of your home and your debt-to-income.

Say you had some dings on your credit report, but you’re coming out of it. Payments are structured so your debt-to-income ratio remains manageable and you’ve got a significant amount of equity in your home.

Lenders, in this case, are likely to approve the line of credit, though likely nowhere near the interest rates you would enjoy with a stellar score. The home provides you with appropriate collateral to secure better terms.

Advantages Include Better Interest Rates

The drawback of HELOC interest rates is that many times, they’re granted according to a variable rate. That is, they can change from month to month, making repayment a bit more difficult to plan for.

That said, the value of your home and the equity you have in it play important factors. Lenders feel more comfortable fronting a better rate with that type of collateral.

More Control Over the Amount Borrowed

As we’ve mentioned, you don’t have to take the full amount of your home equity line of credit. You could be eligible for $100,000 but only need $10,000. Pay only on what you use, and save the rest for when it’s really needed.

Less Pressure When It Comes to Budgeting

Home equity and personal loans can make it easy to budget except for the fact you have to take the full amount and pay it back in higher installments. Opening a credit line gives you more control over what you spend and how you pay it back.

Of course, you’ll want a repayment plan that limits the amount of interest. The wiggle room, however, allows you to scale back without being penalized if you have some unexpected expenses arise for the month.

How to Maximize Your Equity

The calculation is simple. First, determine the overall value of your home. The appraisal value is one area to look at, but you should also examine the type of market you’re in and what homes are selling for on average in your area.

Once you have a good estimate of your home’s value, subtract the remaining mortgage amount. Say you borrowed $140,000 but the remaining mortgage is now $120,000. A home that would sell for $180,000 means you have about $60,000 in equity.

Make Payments Regularly

Growing the amount of available HELOC on your mortgage means you have to keep making those payments. Each month, a certain amount of your payment is applied to the interest and a certain amount to the balance.

As interest goes down, balance goes up. The less of a balance you owe, the more equity you will have in your home. Making each payment on time also improves your credit score and ensures your credit line will be for a significantly higher amount than if you had a lower credit score.

Keep Up Maintenance and Repairs

Your home equity line also is influenced by how well-kept the home is. That’s because diligent maintenance and repairs improve the value of the home. As the value goes up, equity does as well.

Bad Reasons to Use HELOC

A home equity line of credit can be extremely useful for reasons we’ll get into in a moment. However, you might think twice about the following:

  • Basic living expenses: of course, we’re talking about things like car gas, meals out, groceries, clothes, and rent payments. If income can’t keep up with the lifestyle, then you need to reevaluate expenses.
  • Frivolous purchases: high-ticket items that depreciate in value immediately come to mind. Things like boats, cars, hobbies, etc.
  • Speculative investments: cryptocurrencies and FOREX immediately come to mind. Any investment that fluctuates from rags to riches then back to rags while you’re grabbing a drink from the fridge should be avoided at all costs.

Good Reasons

Now that you know how not to spend the money, let’s talk about how you should. Namely, focus on areas that can help you slash debt-service payments or that can actually improve your income. Focus on these four areas, in particular.

  • Business assistance: business expenses, especially those that can help you scale your income. Think outsourcing minor functions or adding a piece of software to help automate and refocus your time.
  • Debt consolidation: credit cards and high-interest personal loans create large monthly payments. Consolidating all into a lower interest rate can immediately slash those monthly payments and get you out of debt quicker.
  • Home improvements: using a line of credit on home improvements like a new HVAC system, structural repairs, or new electrical and plumbing can add thousands of dollars of value to your home.
  • Long-term investments: hinges on the rate you get but worth exploring. Think investing your HELOC with a 3 percent interest rate into a stable mutual fund with an 8 percent rate of return over a 15-year period to grow your investment by 5 percent each year and pay off the principal.

Home Equity Lines of Credit Can Provide the Right Cash at the Right Time

Opening a HELOC delivers flexibility in how you approach wanted or necessary expenditures. It provides control, access to better rates, and a great deal more freedom than personal loans, even if your credit is less than perfect.

Remember, however, that you’re using your home as collateral and that’s not without risks. Always spend responsibly and avoid bad financial decisions with the money.

Ready to get the ball rolling on yours? Apply now or call us toll-free at 1-855-668-3074 to discuss your options.