Maybe you’ve got a really worthwhile project in mind like a college education or advanced degree. The big problem is finding out a way to pay for it. A home equity line of credit, or HELOC, can be a lifesaver. As with a conventional home loan, you tap into the accumulated equity in your home. But a HELOC works like a credit card -- you borrow only what you need, as you need it. Before you rush down to your bank to open a HELOC, you need to calculate how much you can borrow to ensure that you have enough equity built up to meet your needs.
Arrange to have your home appraised. The size of a home equity line of credit depends on the current market value of your home. Some lenders will perform a computerized appraisal for you. If a full appraisal is required, expect to pay the appraisal fee. Before you have an appraisal done, check with the lender. You may be able to select your own appraiser or you may have to use one approved by the lender.
Discuss the terms and conditions of the HELOC with the lender. Lenders set a maximum percentage of a home’s appraised value and won’t lend more; typically this is 75 to 80 percent of the appraised value. For example, if a lender allows 80 percent of appraised value and the market value of your home is $250,000, the maximum you can borrow will be $200,000. Lenders set their own limits, and a few will lend 100 percent or more of a home’s appraised value.
Subtract the outstanding balance of any mortgage(s) you have on your home from the maximum amount the lender will allow you to borrow. For example, if the borrowing limit is $200,000 and you already have a $150,000 loan, this leaves a potential HELOC of $50,000.
Do not assume your HELOC credit limit will be set at the maximum. Lenders review your credit record, income and existing debts. If there is doubt about your ability to pay, you may be turned down or offered a HELOC with a smaller credit limit.
- Opening a HELOC is much like taking out a mortgage. You must pay an application fee and may be charged points and closing costs. These are usually less than for a conventional mortgage.
- A home equity line of credit is not indefinite in duration. You can only borrow for a limited time called the draw period which is typically several years long. Following the draw period, you will have several more years to pay off any outstanding balance on the HELOC.
- When you open a home equity line of credit, you put your home up as collateral. If you run into financial problems and can’t maintain payments, you can lose your home. Also, lenders can suspend or freeze a HELOC if your home’s value falls in an adverse real estate market.
- HELOC interest rates are usually variable. That is, the rate you pay is tied to some financial indicator such as the prime rate and can change. If your rate goes up, you may find yourself making larger payments each month than you anticipated.