Home equity lines of credit have been a great source for both real estate investors and homeowners to enjoy liquid cash when necessary. In the midst of the recent pandemic, many homeowners are looking for extra funds to make ends meet. A home equity line of credit, also known as a HELOC, can be the perfect answer.
What is a HELOC?
A HELOC is like taking out a second mortgage on your home. Many homeowners have built up equity in their homes (especially in a rising market like ours), and they can tap into that equity with this type of loan. One of the best ways to understand a HELOC is to look at an example.
Let's say that you have a home worth $100,000 and your current mortgage is $50,000. That means that you have $50,000 in equity in your home. A HELOC can allow you to tap into some of that $50,000 of equity that you have in your home.
Most lenders will allow you to take up to 80% of the value of your home. In this scenario, 80% of your home would be $80,000. So, you would take $80,000 and subtract the $50,000 that you currently owe on your mortgage. This gives you a HELOC maximum of $30,000. This is referred to as the loan-to-value ratio (LTV).
Why Do Most Lenders Offer 80% of the Value?
Just as a traditional mortgage, lenders limit their risk by keeping a “spread” between the value of your home and the loan amount. For this reason, they will offer up to 80% of the overall value of the home. This gives them 20% of the value of the home as a safety net in the event that the value of the home decreases over time.
What Interest Rates Can You Expect?
Most HELOC interest rates fall between three and seven percent (as of this writing). As with any other type of mortgage loan, HELOCs have an annual percentage rate (APR) that is based on your credit score. Those with a higher credit score generally receive lower interest rates. Those with a lower credit score receive higher interest rates due to the increased risk of lending.
What Credit Score Do You Need To Qualify?
To obtain a HELOC, you're going to need a specific credit score to qualify. Most HELOC lenders require a credit score of at least 680. Keep in mind that 680 is the bare minimum. Applying for a HELOC with this credit score can still prove difficult in some cases.
Most lenders like to see a credit score of at least 700 and preferably 720+. People with a higher credit score will receive better interest rates and a higher loan-to-value.
As you learned above, this will be 80% for most lenders who offer a HELOC for creditworthy borrowers. Those with a 680 credit score may be restricted to a loan-to-value of 65% to 75%. Each lender will have different loan-to-value percentages depending on a borrower's creditworthiness and other factors that contribute to their ability to pay the loan back.
What Can A HELOC Be Used For?
HELOCs can be used for a variety of circumstances. Most lenders will not require you to give them a reason for taking out the loan. You may simply spend the money as you see fit. Some of the most common reasons that homeowners take out a HELOC include:
HELOCs can be used for pretty much anything you would like. It's always a good idea to consider whether or not a HELOC is the right funding option for you. HELOCs are best used to renovate your home to increase its value or to consolidate existing debt to lower the amount of interest you're paying back.
HELOC vs. Home Equity Loan
Many people get the term HELOC and home equity loan confused. While they are similar in the respect of getting money for the equity you have in your home, the similarities stop there. They don't work in the same way. Understanding the difference can allow you to decide what type of funding is right for your needs.
A home equity loan is a typical fixed loan that has a fixed monthly payment with a set borrowing amount. A HELOC, on the other hand, is perfect for those scenarios when you don't know what the final cost is going to be. With a HELOC, you are given a maximum amount of money that you can borrow. You may borrow all or only a portion of the money as you see fit. A line of credit is much like a credit card as you can take out money and pay it back in varying amounts. Additionally, you only pay interest on the amount that you take out.
A HELOC comes with a set APR. This APR will determine what your monthly payments will be compared to how much money you have out at the time. For this reason, HELOCS do not have a fixed monthly payment. Rather, the monthly payment changes depending on the amount of borrowed funds.
Using A HELOC To Finance A Second Home
Many people are investing their time and money in real estate. The idea of having someone pay you rent each month can ring the bells of passive income for anyone. HELOCs are becoming one of the most popular ways to fund the purchase of an investment property. Homeowners are using their existing home equity as a downpayment for a new rental property.
This can be a great strategy for multiple reasons. First, you get passive income from a rental. Second, that passive income can pay for both the mortgage payment for the second home and the HELOC payment for your primary residence. This way, you won't be paying out of pocket to invest in another home.
If you are interested in getting a HELOC, please let me know and I can point you in the right direction. I work with several different top notch lenders who can help you find the right loan for your situation. Contact me here: Connect with Tazz