Perhaps you noticed it when your property valuation statement came in the mail: Your home is more valuable than it was a year ago. There may be an upside — even if you’re not yet ready to sell. If you’re looking to make some updates, whether it’s time to redo the roof, kitchen or driveway, one borrowing option is a HELOC loan.
What’s a HELOC loan? HELOC stands for home equity line of credit. You gain access to a line of credit based on the percentage of equity you have in your home and how much you want to borrow.
The upside of a HELOC is that banks typically extend this line of credit at much lower rates than other forms of revolving credit. Because it’s backed with collateral, something tangible, it’s less risky for lenders.
What’s required for a HELOC?
Mortgage must be less than home value
Typically, homeowners would start thinking about tapping home equity after 5-10 years of making on-time payments. But thanks to the jump in property values, this option is now available to more recent homeowners.
Strong credit history of on-time payments
A good credit score can boost your chances of getting the line of credit you need at a lower interest rate.
Low debt to income
Overextended borrowers make it riskier for the lenders.
What can I use a HELOC for?
Short answer: Anything you want. HELOCs are not limited to home improvements. (Though these are promoted because it can be a great way to invest in your home's value.) These are revolving loans, so you can access the money when you need it.
Pay project expenses
Having your HELOC up and ready before your remodeling project begins can provide a flexible and convenient way to pay for supplies and labor as the project gets completed.
Consolidate debts
Credit card debts, medical debts — HELOC lets you roll multiple balances into a single monthly payment with a low interest rate.
Student loans
If you or your child require private loans to supplement a federal loan package, a HELOC is one option that makes a lot of financial sense, particularly if the interest rate is lower than the going rate for private loans.
Prepare your home for the market
If you’re thinking of selling, a HELOC can give you the capital you need to get your house into top-selling condition. Finishing the deck, replacing worn appliances or converting the attic into a third bedroom are all things that can add value to your property.
Paying off your mortgage
With the recent bump in property values, taking out a HELOC to pay off your mortgage can accelerate the payoff of your home. You could take full advantage of the lower interest rate, but closing costs are typically lower than that of a mortgage.
Would a HELOC loan affect PMI?
Once the loan-to-value ratio of your home dips below 80%, you’re no longer required to pay private mortgage insurance. If you were to take out a HELOC loan, it would not trigger PMI, even if that pushes you back to 80%. That’s because a HELOC loan is a second lien on your house, and PMIs are assessed on first liens.
Which should I pay off first: the HELOC or mortgage?
Typically, you’ll want to prioritize paying down the higher interest loan, versus paying off the lower balances. If your mortgage balance is higher, direct your extra payments there versus your HELOC.
How do lenders set the credit limit for HELOCs?
Typically, the line of credit your HELOC loan offers will be a percentage of your home’s value plus the amount you want to borrow. To find this, you'll want to do some calculations.
First, you'll want to find the loan-to-value ratio:
- Mortgage balance divided by appraised home value.
As an example, let’s say you purchased a home for $200,000 eight years ago. Today, you owe $150,000 on the mortgage, and the current assessed value is $300,000. To calculate LTV:
- $150,000/$300,000 = .50
Then, convert the sum to a percentage and your loan-to-value ratio is 50%.
How much can you borrow?
Does this mean you can borrow against the full equity of the house? Most of the time, no. Most lenders cap HELOCs at 80% against your total equity. If you’re overextended, that makes the loan riskier to the lender.
Here’s how to find the calculated loan-to-value ratio (CLVT):
- Add the loan amount to the current balance. Then divide the sum by appraised home value.
To return to the earlier example, let's say you’d like to take a $30,000 HELOC on your $150,000 mortgage. Before you visit the lender, you'll want to make sure the loan plus your mortgage isn't greater than 80% of the value of your property.
- ($30,000+$150,000)/$300,000 = .60, or 60% CLTV.
As this calculation shows, you'd be well within the range if you were to request a HELOC from a lender.
Ready to make it happen?
Whether you’re looking to speed up your debt snowball, or you’re ready to start a project, talk to a lender at Minnwest Bank. With our quick turnaround time and helpful experts, it’s the perfect lending service for doers like you.
