Top 12 Home Equity Line of Credit (HELOC) Questions Answered

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Advertisements and online promotions representing a Home Equity Line of Credit as a one-stop financial solution sometimes leave homeowners wondering if it’s too good to be true. Having reliable information is vital to making an informed decision when searching for the best HELOC for your unique needs. Before applying for a Home Equity Line of Credit, knowing what costs to compare, features to look for, and mistakes to avoid will help you make an informed decision. If you are considering taking out a Home Equity Line of Credit, the following frequently asked questions and answers could prove invaluable.

1. What is a Home Equity Line of Credit or HELOC?

A Home Equity Line of Credit, also known as a “HELOC,” provides a low-interest borrowing opportunity for qualified homeowners. The amount of credit available is based on the equity in the property. Equity is the difference between the property’s appraised value and outstanding liens. After an impartial appraisal is established, the outstanding mortgage balance and other claims against the property s are deducted to determine the amount of equity. That amount of equity can then be leveraged as collateral. Because a HELOC is secured by collateral (the property), local lenders can offer qualified borrowers increasingly low-interest rates.

It’s also essential to understand that HELOC rates are variable which typically means they are tied to the ebb and flow of the Prime Rate. The Prime Rate is typically determined by a federal funds overnight rate which lenders use to borrow from one another. Most lenders determine their HELOC rate based on the Prime Rate as published in the Wall Street Journal. A HELOC rate is either equal to prime or plus or minus prime. When the Prime Rate is low, a HELOC ranks among the more consumer-friendly borrowing options available. Of course, if the Prime Rate increases, the HELOC rate increases, and borrowers’ monthly payments increase.

To better understand how you use can use a Home Equity Line of Credit, review our blog "5 Smart Ways to Use a HELOC (Home Equity Line of Credit)."

2. How Does a Home Equity Line of Credit (HELOC) Work?

In many respects, a HELOC functions much like a credit card. Borrowers establish a line of credit limit with a lender, and they can withdraw against the amount during a set period of time, otherwise known as the “draw” period. A Home Equity Line of Credit is structured to allow homeowners to spend as they go within the draw period timeframe.

During the initial draw period, borrowers typically only have to pay the monthly interest that accrues. Remember, a Home Equity Line of Credit involves a variable interest rate. That means your payment could fluctuate up or down, depending on the Prime Rate at a given time. Consumers also enjoy the flexibility of choosing to pay the principal they’ve withdrawn to keep the Home Equity Line of Credit at its maximum threshold. This strategy allows homeowners to leverage the same equity more than once before the repayment period begins. As the principal is used and repaid, it becomes available to reuse again.

Draw periods vary, but it’s not uncommon for some to last as long as 10 years. However, repayment periods can range from 5-20 years. The terms of the HELOC are defined by the lender. Once the draw period ends, borrowers start making monthly payments that include interest and principal. This phase of the HELOC starts to mirror many other loan products. If you are used to making interest-only payments, your monthly payment may increase substantially when you transition to paying principal plus interest payments.

A HELOC is akin to a credit card that allows account holders to make purchases up to the amount of their borrowing limit. Unlike a credit card, that limit does not necessarily revolve indefinitely. Home Equity Line of Credit borrowers enjoy flexible access to cash only until the draw period ends and the repayment period begins.

3. How Can I Use a HELOC (Home Equity Line of Credit)?

While a HELOC is secured by the property, the funds from the HELOC do not need to be used only on the property. Some of the most common uses include:

Home Improvement Projects: Making necessary repairs such as a new roof or HVAC system usually buoy property values. Discretionary uses such as upgraded kitchens or expanding bathrooms often improve resale values. This smart use of a HELOC reinvests into a borrower’s home.
Medical Expenses: The cost of quality health care has skyrocketed in recent years. Many insurance policies have high deductibles and don’t cover every procedure. When property owners or a loved one requires surgery, specialized treatment, or long-term care, a Home Equity Line of Credit can ensure your family can pay for the medical attention they deserve.
Family Vacations: Loving families build memories from routine kindness and spending quality time together. Taking a once in a lifetime vacation without worrying about expenses is a dream come true. A HELOC can help fill out the family photo album with nostalgic vacation pictures.
Weddings: Like so many things, wedding expenses have become exorbitant. Too many couples are forced to compromise on their special day when they take their vows. Merging savings accounts with a Home Equity Line of Credit often helps devoted couples plan a perfect wedding.
Financial Investments: It’s not uncommon for intelligent real estate investors to leverage equity and purchase a second property. This strategy puts equity to work by integrating a profit-driving rental property into a portfolio. Beyond pure business, retirees sometimes use a HELOC to secure a second home and enjoy seasonal weather during their golden years.
College Expenses: Using a HELOC for college tuition and other college related expenses often offers borrowers a better interest rate than one would receive from other loans, especially if you have good credit. A HELOC also allows borrowers to withdraw the amount they need and only requires interest to be paid on the amount borrowed during the draw period. This flexibility is valuable when you are unsure of the exact funds you will need to cover various expenses throughout the higher education experience.
Debt Consolidation: A HELOC can help streamline and consolidate existing bills into one easy-to-manage monthly payment. The interest rate on the HELOC is typically lower than what a borrower can usually expect from a credit card., Still, every borrower’s credit score and financial situation differ, so due diligence is required.

The flexible uses of a HELOC sometimes lead people to think of them as a high-limit credit card. But it’s essential to plan where your money will go ahead of time because when the draw period concludes, borrowers begin repayment and will no longer have access to funds.

4. How Much Money Can I Borrow with a Home Equity Line of Credit?

Property owners sometimes speculate about how much they can get approved for when applying for a Home Equity Line of Credit. The answer to that question rests primarily on how much equity they possess, their credit score, and other financial indicators.

5. How Much Home Equity Do I Have?

If you are considering applying for a Home Equity Line of Credit, calculating the amount of equity you possess doesn’t require overly complicated math. Write down the current amount owed on your mortgage and the total of other encumbrances (or liens on the property) to determine your total home debt. Take that number and subtract it from the fair market value of your property.

If your total home debt tallies $200,000, and the value is estimated at $400,000, you have established 50 percent equity. That $200,000 in equity could support a Home Equity Line of Credit of about $160,000 if the lender is willing to approve at the 80-percent threshold.

One of the peripheral questions prospective borrowers often ask is whether they need to pay for an appraisal to get approved for a HELOC. The answer depends on whether you want to take advantage of quick-rising real estate prices or base the HELOC application on established value. If you provide a tax document that proves its value and, by extension, the equity, lenders may waive the appraisal process, saving the borrower some money.

If you are wondering if using your home's equity as a loan is a good decision, review our blog "5 Pros and Cons of Using a HELOC for Home Improvement Projects."

6. Besides HELOC Rates, What Else Impacts My Total Loan Cost?

It’s not unusual for people to get caught up in HELOC rates and forget that other expenses can drive up costs. When shopping for a Home Equity Line of Credit, the following rank among the expenses and fees that are sometimes overlooked.

Origination Fee: Some lenders call this an application fee and the expense has become something of a standard practice. It deters people who are not qualified from overwhelming loan processing professionals.
Title Search Charges: Lenders must make certain the person receiving the HELOC funds owns the property. That’s why title searches are a necessary part of the approval process.

There are several HELOC-specific expenses borrows can anticipate. In addition to the charges above, be sure to compare the cost for these possible charges: Loan Processing Fee, Flood Zone Determination Fee, Appraisal Fee, Title Report Fee, Recording Fees, and Transfer Tax. Always be sure to identify which of these charges will be included in the total loan amount that will be affected by the APR (Annual Percentage Rate) versus costs due to third parties that will be due at closing.

Be Aware of the Introductory and Promotional Offers Impacting Your HELOC Rates

In addition to fees, be aware of the terms surrounding an introductory or promotional offer tied to your HELOC Rate. Always ask questions and read the fine print to find what your rate will be once that introductory or promotional period ends.

To get a closer look at the items and fees you should compare when shopping for a Home Equity Line of Credit, review our blog "HELOC Rates Aren't The Only Thing to Watch When Searching for a HELOC."

7. How Does the Prime Rate Affect My Home Equity Line of Credit Rate?

The prime rate has considerable influence over a Home Equity Line of Credit. A HELOC is usually tied to this benchmark figure, impacting borrowing power and actual dollars paid in interest. For example, the month-over-month interest repayment typically required during the draw period can fluctuate up or down in sync with the prime rate.

This variable-rate option also is impacted by the prime rate adjustments that trickle down from actions taken by The Fed. That means borrowers could see their monthly installments shift even after they finish using the line of credit and enter repayment. When considering a HELOC, it’s important to understand the economic factors and how The Fed’s actions could impact your bottom line.

To better understand how the prime rate will impact your HELOC, review our blog "Prime Rate Explained: See How It Impacts HELOC Rates and Your Wallet."

8. How Do I Qualify for a Home Equity Line of Credit?

To qualify for a Home Equity Line of Credit, a lender routinely examines a homeowner’s credit score, debt-to-income ratio, and calculates the property’s equity. It’s not necessarily crucial to post perfect credit metrics. A loan professional generally reviews someone’s financial portfolio in its totality. So, being strong in one area may help compensate for a weakness in another.

Lenders prefer debt-to-income ratios to be no higher than approximately 43 percent. An applicant’s FICO score also carries considerable weight, and the lenders like to see numbers no lower than 680 in many cases. High scores may help expedite the approval process and provide access to low-interest products and more flexible terms. Lastly, the equity someone possesses and the amount they wish to use as collateral significantly impacts the process. For example, leaving more than 20 percent untouched improves the security of the Home Equity Line of Credit and the lender’s position in the event of default.

Borrowers would be well-served to review their credit score and debt-to-income ratio and estimate the equity in their home. Clear up any credit blemishes and tighten that debt-to-income ratio. With those figures in hand, schedule an appointment with a local lending professional and find out what is available to you.

9. Does a Home Equity Line of Credit Affect My Credit Score?

Anytime someone applies for a loan, credit card, or line of credit, the inquiry has a minor effect on their credit score. Your score may drop by a few points (if anything at all), but the impact disappears over time. The same holds after borrowers are approved, and that debt is added into the mix. The fundamental fact is that a HELOC can help or hurt your credit score, depending on how you use it. You can help your credit score by making payments on time, and you can hurt your credit score by missing or making late payments.

10. Do my HELOC and Mortgage Need to Be with the Same Lender?

No, your mortgage and HELOC do not need to be with the same lender. If you have a mortgage and want a HELOC, you should research and shop around for the best available product that fits your needs. Be sure to compare the promotional rate, and the rate after the introductory period ends, along with the various fees included in the process.

If you are planning to purchase a new home or refinance your mortgage, you can incorporate a HELOC application at the same time.

If you already have a HELOC and want to change lenders, you can refinance your HELOC the same way you would refinance a mortgage. Some situations may benefit from combining both. Every borrower’s financial situation is unique, working with a local community bank like Middlesex Federal Savings can help you decide which option is best for you.

11. Where Should I Apply for My HELOC Loan?

Many lenders offer a Home Equity Line of Credit, but that does not mean the product or experience is the same. Be sure to conduct research to find the best product and lender to fit your needs.

When you apply for a HELOC with Middlesex Federal Savings, you can expect sound financial advice and a familiar face to help answer your questions and guide you throughout the entire process.

As a local community bank, Middlesex Federal Savings has served our friends and neighbors with local decision making for more than 130 years. We are passionate about investing in our community and helping our customers find the right product to fit their needs.

12. How Long Does a Home Equity Line of Credit Application Take to Get Approved?

A wide range of resources indicates that homeowners typically get approved for a Home Equity Line of Credit between 30-45 days on average. But people who work with local lenders often find they can truncate that timetable to as low as 2-3 weeks in some instances. If you have your financial ducks in a row and do not need to hire an appraiser, the process can be significantly streamlined.

A Home Equity Line of Credit is a flexible, low-cost solution to help you achieve your goals. Whether you use the funds to renovate your home, pay for an emergency repair or large purchase, cover planned or unexpected medical costs, help pay for a college education, and so much more. Applying for a Home Equity Line of Credit is fast and easy! Fill out our application today and know that Middlesex Federal Savings is ready to help you every step of the way.