If you’re eager to renovate or remodel your home but don’t quite have enough savings to cover it, you might think a home equity line of credit (or HELOC) could help you scrape together the cash for the job.
But what exactly is a HELOC, and is it really a good financing option for things like a home remodel, new furniture or even college tuition? We’re here to help you find out!
What Is a Home Equity Line Of Credit?
A home equity line of credit, or HELOC, is a type of home equity loan that allows you to borrow cash against the current value of your home. You can use it for individual purchases as needed up to an approved amount, kind of like a credit card. And it uses a revolving credit line, which means you have access to a circulating pool of money as you borrow from the HELOC and pay it back.
But with HELOCs, it’s easy to suddenly find yourself in a tight (even critical) financial spot—especially if you’re carrying a high HELOC balance.
How Does a HELOC Work?
A HELOC is different from a regular credit card or loan because it uses the equity in your home as collateral. Don’t miss that: A HELOC uses the equity in your home as collateral. Yikes! And your home equity is the portion of your home you own outright, so it’s the difference between how much your home is worth in the current market and your mortgage balance.
Let’s say you’ve been approved for a HELOC, and your credit line is $40,000.
You spend $35,000 of it updating your kitchen. (Hey there, subway tiles and shiplap.)
You would only have $5,000 left to use until you replaced the $35,000 you originally borrowed from the pool.
And when it comes to paying back your HELOC in minimum monthly payments—like most people who use credit cards or credit lines do—this will not fill your pool back up very quickly, especially with all those interest charges!
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Important things to know about paying back a HELOC:
Repayment: There are a lot of different borrowing and repayment schedules for HELOCs, but most people looking to get a HELOC want a long-term, 30-year repayment option. Yes, 30 years!
Interest rates: Fixed-rate HELOCs are rare. So you’ll need to be prepared for fluctuating interest rates over the life of your credit line. Those rates are basically set by the lender, and they’re definitely not based on the market as we might be led to believe.
Immediate payback and credit freezes: Once your credit term expires, the balance must be paid in full. The same is true if you sell your home. And even if the loan doesn’t expire, the bank can freeze your credit line if the value of your home depreciates below its appraised value.
How Long Does It Take to Get a HELOC?
Once you apply for a HELOC, it can take a few weeks from application to approval because a HELOC is really like a second mortgage. So applying for one is similar to applying for your first mortgage.
Lenders will go through a formal process of evaluating your financial situation and home equity to determine if you’re a credit risk or not. They’ll look at your:
Home’s current equity
Home’s appraised value
Proof of employment and income
After verifying these things, lenders will decide how much of a credit line they’re willing to offer you. In most cases, borrowers are approved for around 80% of their home’s equity.
Let’s say your home is worth $180,000, and you still have $100,000 in your mortgage balance. You’d have $80,000 in equity you could potentially access through a HELOC. So you’d likely be approved for a credit line of $64,000, which is around 80% of your equity.
HELOC Closing Costs
Applying for a HELOC comes with closing costs, just like your mortgage did!1 And once you get the offer, you’ll need to agree on that fine print we mentioned earlier. This is where you’ll really need to pay attention, because it will detail the fees and costs of your HELOC.
HELOCs have the same up-front costs as a mortgage, including lender fees. These fees enable your lender to process the HELOC, check your credit, appraise your home again, cover legal costs to prepare documents, and cover origination fees for the opening of your HELOC account.
And once you’re approved for your HELOC, continuing costs will kick in, like:
Transaction fees: These pop up every time you borrow money from your HELOC.
Minimum withdrawal: Most HELOC accounts will come with a minimum amount of money you can withdraw. And because of this (and because of your lender’s interest rates) you’ll be paying interest on your withdrawal even if it’s for more money than you actually needed to use!
Inactivity fees: If you’re not using your HELOC for a long time (read the fine print to see how long), your lender could charge you a fee.
Early termination fees: Your lender might require your HELOC account to be open for a certain amount of time (around 3–5 years). If you wanted to cancel it before this period, you’ll have to pay a cancellation fee (which could run into the thousands).
Required balance: Your HELOC could have a required balance, which would mean you’d be paying a certain amount of interest on it each month whether you’re using your HELOC at the time or not.
HELOC vs. Home Equity Loan: What’s the Difference?
A HELOC is not much different from a home equity loan. The main difference is that a home equity loan allows you, the borrower, to take the full lump sum you’ve been approved for all at once rather than the charge-as-you-go method with a HELOC.
Both the HELOC and home equity loan are similar in that you borrow against the equity in your home. But home equity loans are likely to have a fixed rate of interest, so your monthly payments are a little more predictable compared with a HELOC and its variable rates.
Is a HELOC a Good Idea?
By now, your kitchen cabinets and countertops might not be looking as shabby as when you first started reading. That’s because HELOCs are not the answer to your cash-flow problem. Here’s why:
1. You’re putting your home at risk.
Just because HELOCs seem common doesn’t take away from the fact that they can also carry serious consequences. If you default or misstep in any way, the bank could take your home! Is that new bedroom furniture you just have to have or that 10-day vacation really worth losing your home over?
2. Saving and paying cash is smarter in the long run.
Taking on debt of any kind robs you of true financial peace. When you lay your head on the pillow at night, what would you rather be thinking about: planning a party in your paid-for kitchen, or making payments on your new marble countertops . . . for the next 30 years?
With tools like Dave Ramsey’s 7 Baby Steps, you can create and stick to a savings plan. You’ll still have that remodel project done in no time—but it’ll be finished debt-free!
3. HELOCs don’t really create cash-flow.
Plain and simple, a HELOC is debt. And debt doesn’t make anything flow but tears. The best way to create cash-flow is to pay off all your debt using the debt snowball method. Increasing your income through a second job or smart investments can generate extra money for things like home improvements, college tuition or your kid’s wedding.
If too much of your income is going toward your mortgage payment, you could also consider selling your home and downsizing to one that’s more affordable. Use our mortgage calculator to see if this option is right for you!
Before you commit to a HELOC and borrow against what is the biggest asset you own, make sure you consult with an experienced financial expert. It’s the best way to figure out if you’re making a smart financial decision for your family.
The financial experts at Churchill Mortgage have helped hundreds of thousands of people plan smarter and live better. Reach out to them today!