The home equity line of credit -- or HELOC -- was wildly popular until a few years ago. The product took a lot of heat for making it easy for homeowners to bury themselves financially, and for the erosion of home equity leading up to the mortgage crisis in 2007. "Using your home as an ATM" became one of the most overused phrases in personal finance journalism.
Although we have not heard too much about HELOCs in the past few years, the time for their return may be ripe.
According to Compass Point Research and Trading, the value of US homes has grown by more than $2 trillion during the past year. The Federal Reserve pretty much agrees and says home values increased $2.3 trillion in 2013. If your wallet feels a little fatter lately, it's not an illusion; home prices rose substantially during the past year, creating more equity in many markets.
Having more equity creates an interesting dilemma: homeowners can let it sit, or they can put it to work funding college educations, starting new businesses or consolidating higher-interest consumer debt. Those who don't need to tap their home equity now may still wish to set up low-cost HELOC as a source of emergency credit.
HELOC Interest Rates
As with all mortgages, it pays to compare interest rates among competing lenders. As of this writing, starting HELOC mortgage rates are below four percent in some cases, depending on such factors as the size of the loan, the amount of equity and your credit standing.
Keep in mind that "starting rates" are just that -- because a home equity line of credit comes with an adjustable mortgage rate. Your monthly payment is determined by your loan balance and the interest rate, and can change every month.
If you are considering a HELOC, be sure to ask when the loan adjusts, how much of an interest increase is allowed per adjustment, how often the loan adjusts and the highest allowable interest level over the life of the loan.
Not only are start rates typically low, the cost to set up a HELOC is often minimal. Many lenders offer home equity lines of credit with no closing costs. However, the definition of "no closing costs" varies, and you may need some cash for various expenses. Have the lender outline your likely settlement expenses before accepting any loan offer. Ask about such possible costs as an application or loan processing fee, origination costs, a funding fee, appraisal charges, broker fees and any other expenses related to the transaction. Also ask if there is a minimum amount which must be taken from the account when it is first set up.
Given that up-front charges may be very small, the best strategy is likely to get the largest home equity line of credit you can. Getting such a line of credit does not mean you have to spend all of it, but it's available to you in most cases.
How Much Can You Borrow With a HELOC?
How much can you borrow with a home equity line of credit? In the usual case a lender will provide a line which leaves you with 20 percent equity. For instance, if you have a $250,000 home and a $125,000 mortgage balance, you may be able to get a $75,000 HELOC, for a total of $200,000 in debt. That leaves 20 percent equity in place.
One caveat: money in a HELOC is usually available but not always. For instance, when home prices fell in 2008 many lenders responded by suspending HELOC withdrawals. This was a surprise to many homeowners. While such curtailments are not likely to happen again, they are now within the realm of possibility and should be considered.
Some lenders may be prepared to make larger loans, but check costs and fees. Also, with all HELOCs, ask if the lender requires "credit insurance" and, if so, at what cost.
Once you have the loan, it's important to know how long the HELOC lasts and whether you can prepay any balances without penalty. Typically, HELOCs have two phases -- a draw period, during which time you can withdraw funds, and a repayment period, in which you cannot withdraw any more money but must repay your balance. For instance, a 15-year HELOC may have a 10-year draw period and then five additional years to repay the debt.
For more information, start comparing HELOCs with our network of lenders.