With home values rising in most areas of the country, many homeowners are interested in a home equity line of credit to access cash — especially to fund remodel projects or major home improvements.
In fact, the median existing-home price for all housing types in July 2019 was $280,800, which is up 4.3% from July of 2018 ($269,300), according to the National Association of Realtors. This gives many homeowners options to use that rising value — and their earned equity — to their advantage.
A home equity line of credit (HELOC) is a secured loan with your house as collateral with no restrictions on how you can use the money. In addition to home improvements, the funds can be used to pay off medical expenses or help your child with college. But remember, if you take out a home equity line of credit against your house and you can no longer afford the payments, the lender can require you to sell your home to pay back the loan.
Home equity line of credit interest rates
Home equity interest rates are typically variable and are tied to the prime rate. What is the prime rate? It’s the interest rate that commercial banks charge their most creditworthy customers — usually large corporations. The prime rate is important for individual borrowers too, as it directly affects the interest rates available for mortgages, small business loans, and personal loans.
The current prime rate is 5.25%. HELOC rates are usually set as the prime rate plus 1%-2% more, which can adjust monthly.
“Home equity loan rates vary from lender to lender and it’s not a bad loan for well-qualified borrowers,” says Mark McClurg, mortgage expert at Envoy Mortgage. But, he’s also seen the prime rate change rapidly. “When interest rates increase 0.5% here and 0.5% there, it can add up. It can change your payments dramatically.”
McClurg also warns of “teaser rates” for home equity loans.
“These are designed to bring in customers. But, they may only last for 3-6 months, then the rate rises dramatically. Make sure your rate is clearly defined in the paperwork and what changes will happen when.”
HELOC lending limits
With a home equity line of credit, you’ll only have access to a specific amount of credit. Lenders set a credit limit by taking a percentage of the home’s appraised value and subtracting the balance you owe on your mortgage. The exact percentage will vary lender to lender, but is typically 75%-90% of the appraised value. Lenders will also consider your income, current debts, other financial obligations as well as your credit history.
HELOC Calculation Example
|Appraised value of home||$100,000|
|Percentage of appraised value||= $75,000|
|Less balance owed on mortgage||– $40,000|
|Potential line of credit||$35,000|
How to find the best HELOC terms
The Federal Trade Commission suggests asking friends and family for recommendations of lenders and then to shop around. Reach out to banks, credit unions, mortgage companies and make sure to compare each lender’s terms and conditions. Also, pay close attention to fees as well as points, financing charges, and closing costs. These could mean higher costs.
With a home equity line of credit, you can pull money out at intervals whenever you need it — at least for a period of time. Many HELOCs have a set fixed period, typically 10 years, when you can borrow money. This is called the “draw period” and you may be able to renew the credit line.
“You can usually only draw from a home equity line of credit for 10 years, and then you have to reapply. But, that will vary from lender to lender,” McClurg says.
Not all plans allow for renewals, however. At this point, you’ll have to start making payments. Some plans require payment in full of any outstanding balance, while others allow for repayment over a fixed period of time (also, known as the “repayment period”).
Is an appraisal required with a HELOC?
In general, a new appraisal will be required to qualify for a home equity line of credit. Though, some credit unions and banks will use county assessments and automated value models.
“There is a lot of data available to support neighborhood values. Instead of an appraisal, sometimes lenders will do a drive-by appraisal with a few photos taken,” says McClurg.
However the lender determines a current home value, it’s needed to calculate the amount of credit you’ll be eligible to borrow.
Alternatives to a home equity line of credit
If you need access to cash, but a HELOC doesn’t sound like a right fit for you, there are a couple of alternatives that you should consider. Those options, include:
Personal Loans. This is a good option if you don’t want to touch your home’s equity to access cash. Unlike a HELOC, where you take out funds as needed, a personal loan is a lump sum — typically, you can fund up to $100,000. They’re also relatively quick and inexpensive to process, meaning you have access to cash usually within a week if not sooner compared to several weeks with a HELOC. Keep in mind, terms are generally much shorter and interest rates are based on your credit history. In general, the lower your credit score, the higher your rate.
Cash-out Refinance. This refinance loan is similar to a HELOC in that it allows you to tap into your home equity and turn it into cash by refinancing your current loan for more than you owe. Because this is a refinance loan, the documentation and appraisal requirements are similar to a HELOC. But, you also have the potential of lowering your monthly payment and removing private mortgage insurance in some scenarios.