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Home»Mortgages»Everything You Need to Know About Home Equity Line of Credit
Mortgages

Everything You Need to Know About Home Equity Line of Credit

Biz GeldBy Biz GeldNovember 13, 2021Updated:June 14, 2022No Comments7 Mins Read
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It is a big decision to buy a house, and the first step should be to find out how much you can afford. The next step would be to know what type of loan you want. 

If you have equity in your home, this could be an option for financing your purchase or refinancing your current mortgage. Equity is the difference between the balance owed on the property and its fair market value (FMV). 

There are many reasons why someone might seek a home equity line of credit, such as

  • Paying off debts that were not included in bankruptcy proceedings.
  • Buying a new car.
  • Paying for college tuition.

If it seems like something that may work for you, here is everything you need to know about the home equity line of credit.

What is the Home Equity Line of Credit?

One of the biggest advantages that homeowners have is building equity in their homes over time. But there may come a time when you don’t have enough equity to take advantage of it. 

A home equity line of credit is a second mortgage, which will allow you to use your available equity as you need it. It will also provide liquidity if ever required in the future.

With this loan, you will receive a credit line, which you can draw on up to a predetermined amount when you need it. You will have the option of getting money in a lump sum or through a series of monthly installments.

A home equity line of credit is useful for making emergency repairs on your property, consolidating debts with higher interest rates, paying for college tuition, and covering medical expenses.

How does the Home Equity Line of Credit work?

With the home equity line of credit, you will be borrowing money based on your available equity. The proceeds are usually paid directly to the borrower or sent as a check payable to whomever you designate, such as an auto dealer for car repairs. 

You can also choose to have the lender hold onto the money until needed and pay it back as a lump sum or through monthly installments.

A home equity line of credit is open-ended, and you can use the amount at any time. It’s important to note that if you do not use the entire credit limit within one year, it will be reduced as terms and conditions change.

What are the Qualifying Requirements for a Home Equity Line of Credit?

Your lender will review your credit report to determine if you qualify for a home equity line of credit. Your credit score is an essential factor in getting the best possible interest rate. 

You will have a better chance at receiving low rates when you have a high FICO score which should be at least 740.

The credit line available to you will depend on the value of your home, which should be equal to no less than 80% of its FMV (Fair Market Value). 

Your lender may require that to be appraised by a professional before you are approved for the loan. You have to meet certain requirements to qualify for this loan, including being at least 18 years old, having an income or Social Security number, and credit score.

What Documents Do you Need to Apply for Home Equity Line of Credit?

There are several documents that you need to apply for this loan, such as

>> Proof of income.

>> Proof of Social Security Number.

>> Deed of trust documents for the property financed along with a recent appraisal report.

>> Personal information such as employment history, personal credit score, and other financial accounts you have to determine how much you qualify for. Your lender will request bank statements, credit card information, and other financial documents for assessment.

The required documents and paperwork may vary from lender to lender. But these are the documents that are typically needed, along with an application form that you should receive from your lender.

Difference between a HELOC and a traditional second mortgage

A home equity line of credit is not the same as a second mortgage, but it does function in much the same way. With both loans, you are borrowing against your home’s value to pay off other debts or expenses that you can not afford with your current income.

So what’s the difference? Below are six differences between HELOC and a traditional second mortgage.

1. While you can use the money in your home equity line of credit at any time, you cannot withdraw funds from a second mortgage without paying penalties.

2. The money in your HELOC will be available to you when it’s needed, whereas, with a traditional mortgage, you have to wait for specific periods (usually annual) to withdraw funds.

3. A HELOC typically comes with a lower interest rate than a traditional second mortgage. That means your monthly payments will be less expensive.

4. The lender of your HELOC will allow you to borrow up to 80% of the value of your home. In contrast, a second mortgage typically will allow a smaller amount.

5. Home equity lines of credit can be a better choice for those who want to borrow money from time to time. This is because it comes with a revolving credit limit, which you can use as needed. 

Suppose you have a fixed monthly income and know exactly how much you need each month. In that case, the traditional second mortgage may be more suitable.

6. When it comes to interest rates, the lender of your second mortgage will typically offer a lower rate because you are borrowing much more money. The interest rates on home equity lines of credit may vary depending on the lender and when you receive your credit limit.

Advantages and disadvantages of HELOC

There are both advantages and disadvantages to receiving a home equity line of credit.

Advantages:

>> It has a lower interest rate than other types of loans or lines of credit you can get. This is because the lender doesn’t have to worry about your house being repossessed if you default on the loan.

>> Your monthly payments are based on your credit limit, so you will only have to make payments on the amount of money you actually borrow. That means your monthly obligations are much lower than those of a typical loan or line of credit where you pay interest on the full balance from day one.

>> A HELOC is typically available from most lenders when they receive all the paperwork needed to process the loan. It means that you can get the money you need quickly and efficiently, without having to wait for approval or for all your financial information to be approved.

>> Home equity line of credit is very flexible. You can use it anytime for whatever purpose you choose, whether it’s an emergency expense or you need to make home repairs.

>> You can get a higher credit limit than credit cards or other loans if you have a good credit score. This means more borrowing power and better access to capital when it’s needed.

Disadvantages:

<< It may come with a minimum withdrawal limit. Some lenders will only allow you to withdraw a few hundred dollars at a time, regardless of the credit limit available to your account.

<< If you don’t pay your payments on time, your credit score may go down. That means you may have to pay even more for future loans, including your HELOC payments, because of the missed payments.

<< You are only allowed a small amount of money each time you withdraw it from your account. If you need more money, you have to contact the lender and ask them to increase your credit limit. 

If you do this, the lender may charge a fee for increasing your credit line. It may also increase your monthly payments because you will be charged interest on more money.

Bottom-Line

A home equity line of credit is a great way to get money for whatever purpose you need. It can be a lifesaver when it comes to emergencies or any financial stress. 

Just make sure you only borrow the money you know you can pay back when it’s due, so you don’t get into severe financial trouble.

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BizGeld provides well-researched and free finance educational content to help you make informed financial decisions. Although we provide unbiased information and recommendations, we are not your typical financial advisor. So before making any financial decision, please contact a professional.

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