What is a Home Equity Line of Credit?
Have you heard the phrase “home equity line of credit” or seen the abbreviation HELOC but have no idea what they mean? It can be confusing. But at Rivermark Community Credit Union, we want to make finance easy to understand. That’s why we’re going to explain what a home equity line of credit actually is and when you should apply for one.
Home Equity Loan vs. Home Equity Line of Credit
It’s important to first note that there’s a difference between a home equity loan and a home equity line of credit. When you take out a home equity loan, you’re borrowing money in a lump sum. This means you get the entire amount of money at once. With this loan, the interest rate is usually fixed. When you take out a home equity line of credit, you have a maximum available amount that you can take money from multiple times as needed. This maximum amount tends to be about 85 percent of your home’s value minus the amount you owe (that is, your mortgage). If you’re interested in what your home equity is, use our easy calculator. HELOCs tend to have an adjustable interest rate.
If you need a large amount of money at once or if you want an interest rate that stays the same, then taking out a loan may be better for you. However, if you prefer to take out the money as needed, rather than as a large lump sum (and don’t mind an adjustable interest rate), a home equity line of credit may better suit you.
At Rivermark, we offer both options. Our home equity loan will let you borrow a predetermined amount of money that you can use as you wish. You then repay this loan on a fixed, monthly schedule. If you choose the home equity line of credit, you’ll receive a credit line that’s revolving. It will give you unlimited access to the credit line until you hit your available credit limit.
When Should I Get a Home Equity Line of Credit?
In most cases, in order to qualify for a home equity line of credit, you need to have a debt-to-income ratio in the lower 40s or under. You’ll also need a home value that’s at least 15 percent more than you owe and a credit score in the range of 620 or higher. If you meet these criteria, you shouldn’t have an issue receiving the line of credit.
If you’re at the risk of foreclosure (that is, if you won’t be able to make the monthly payments), you shouldn’t take out a home equity line of credit. Most people choose to get HELOCs when they’re repairing or renovating their homes, which should increase the value of their homes in the long-run. Additionally, if you do use your HELOC to buy, build, or improve your home, the interest may be tax-deductible.
Another reason to get a HELOC is to pay for education.
When Should I Not Get a Home Equity Line of Credit?
When it comes to other major expenses, such as cars or vacations, it isn’t recommended, as those major purchases aren’t an investment and won’t allow you to build further wealth.
Similarly, if you’re thinking about taking a HELOC out for your basic, everyday purchases to help make ends meet, it’s not a good reason either. Whereas the extra money may be tempting and extremely beneficial, it can be risky to take out a HELOC, as you may, in turn, get yourself into more debt if you’re unable to make the payments.
Furthermore, you also shouldn’t take out a home equity line of credit if:
- Your income is unstable
- You don’t need to borrow that much money
- You can’t afford the upfront costs that come with a HELOC
- You can’t afford the potential for the interest rate to increase
It could do more harm than good, and you should look into other options. Some of the upfront costs can include an application fee, an appraisal fee, a title search, and even attorney’s fees. All of these costs should be taken into consideration because you need to be able to pay them fully if you choose to get a HELOC.
Impact on Credit Score
The impact on your credit score can vary, but some credit bureaus won’t treat HELOCs like a revolving line of credit. If they’re of a certain size, they’ll treat them more like installment loans. This could actually have less of an impact on your credit score than maxing out your credit card would. Of course, it will still affect your credit score by reducing it temporarily; however, the effect might not be as bad.
As mentioned above, your credit score is important in terms of determining whether you’ll be eligible for a HELOC. Be sure to check your score before applying for one to make sure that it’s around 620 or higher.
A home equity line of credit is a good idea in some cases, but it’s not for everyone. It can also be easily confused with a home equity loan, though the two are distinctly different. One works better for some people and situations, and the other works better for others. It all depends on your needs and your finances. It’s important to understand the difference between the two before you decide which one is best for you. You also want to be sure you’re getting a HELOC for the right reasons and not simply for everyday expenses.
If you’re still unsure whether a home equity line of credit will work for you, feel free to connect with us at Rivermark, and we can answer your questions. If you think you’re ready to take out a HELOC, you can apply online with us today.