When looking for a new line of credit, people don't often consider their own homes as a funding source. But, believe it or not, you can tap into a home equity line of credit (HELOC) even if your mortgage isn't paid off yet.
Here's what to know about HELOCs and how you can use them to your advantage.
What Is a HELOC?
A home equity line of credit, or HELOC, is a revolving line of credit that allows homeowners to borrow money against their home's equity. It essentially allows them to access funds using their homes as collateral.
HELOCs differ from traditional loans in that they offer a predetermined credit limit and borrowers can continually withdraw funds as needed — they don't receive a lump sum upfront. Typically, HELOCs have variable interest rates and offer flexibility in terms of borrowing and repayment.
What Are HELOCs Used For?
The great thing about HELOCs is that they're incredibly versatile. Whether you're looking to renovate your home, pay for your child's education, or anything in between, having access to a HELOC can really save the day. Here's a closer look at what they can be used for.
Home Improvements and Renovations
Home renovations are the dream of many, but some homeowners lack the funds to pay for improvements upfront. That's where HELOCs come in. They can help pay for minor upgrades like painting or new appliances or even major renovations such as adding a room or remodeling a kitchen.
But is this wise? Using HELOCs for home renovation can be a smart move because it can increase the value of your home, making it a worthwhile investment. For example, a garage door replacement offers an average ROI of 102.7%.
Debt Consolidation
Consolidating multiple debts into a single payment can be extremely helpful in terms of personal finance management. This is another area where a HELOC can come in handy. Since HELOCs usually come with lower interest rates than credit cards and unsecured personal loans, they can offer major savings to homeowners.
Emergency Funds
Everyone needs a good emergency fund. Using a HELOC is a great way to prepare for the unexpected. At some point in your life, you're likely to face mounting medical bills, urgent home repairs, or job loss. When disaster strikes, having a HELOC can give you some peace of mind.
Education Expenses
If you're back in college after some time or have a kid in school, you can use a HELOC to finance everything from tuition to living expenses. This can be a great alternative to student loans. Do note that unlike student loans, HELOCs are secured by your home, which means failure to repay could put your property at risk. Consider the trade-off and expected ROI of your education before using this credit.
Major Purchases
HELOCs can be used to fund items and events that would otherwise require a loan, like a new car or wedding. Bear in mind, though, that these purchases do not add value to your home and won't necessarily offer any ROI in the future.
Before making any decision, it's important to consider whether or not the purchase is truly worth the risk. While we all like to get new things from time to time, borrowing against your home's equity for a personal purchase can be dangerous in the long run.
Bridge Loans
Often, homeowners require temporary loans to bridge the gap between buying a new home and selling their current one. HELOCs can be used as bridge loans and are especially useful in competitive real estate markets where it's necessary to make an offer on a new home before selling the one you're already in.
Tax Planning
Let's face it, no one likes taxes, but HELOCs can help soften the blow. The interest on a HELOC may be tax-deductible if used for home improvement or buying, building, or otherwise improving the property. Consult with a tax professional to understand your options and see what benefits you are eligible for with a HELOC.
How Do I Know If I'm Eligible for a HELOC?
If you're thinking about getting a HELOC, there are a few things to consider. First, you need to determine your current home's equity or the difference between the current market value of the house and the amount owed on the mortgage.
Most lenders like Philadelphia Federal Credit Union (PFCU) lend 80 to 90% of the home's value. PFCU lends 80% of the value for a HELOC. You can calculate your built equity by getting an appraisal of your home's current market value and subtracting the amount still owed on the mortgage.
Take, for example, a home valued at $300,000. If the homeowner still owes $200,000 on the house, their equity would be $100,000. If a lender's maximum is 80% financing, this means the homeowner could borrow up to $40,000. They would likely qualify for a HELOC.
Your credit score also factors into your HELOC eligibility. Lenders look for scores in the good to excellent range — around 620 or higher. Usually, the higher your credit score, the lower your interest rate. Be prepared for lenders to scrutinize your credit report for payment history, outstanding debts, and overall credit utilization. A history of late payments or bankruptcy may make you ineligible for a HELOC.
The third thing most lenders will look at is your debt-to-income (DTI) ratio. This ratio compares your monthly debt payments to your monthly income. Most lenders prefer a DTI ratio of 40-50% or lower. To calculate your DTI ratio, add up all your monthly debt payments and divide by the gross monthly income. If your number is high, you may need to pay down some debts before qualifying for a HELOC.
Your lender will also likely assess your ability to repay the loan. They'll review your income sources, employment stability, and financial reserves. Stable employment and a steady income stream indicate your ability to make regular payments. In that way, you look like less of a risk to lenders.
Myths (and Truths) About HELOCs
There are a lot of misconceptions surrounding HELOCs. Before taking the plunge and opening a credit line, it's important to know exactly what you're getting into.
Myth: HELOCs and Home Equity Loans Are the Same Thing
HELOCs are often confused with home equity loans. While the two have similarities, they're also different in some ways. A home equity loan is a lump sum loan with a fixed interest rate and set repayment term.
HELOCs are revolving credit lines with variable interest rates. In other words, home equity loans are a "one-time" thing, whereas HELOCs are ongoing and can serve your financial needs for many years.
Truth: HELOC Interest Rates Are Typically Lower than Credit Cards
You may have heard that HELOCs offer better interest rates than credit cards — and that's definitely true. This is because a HELOC Is secured by your home, which offers significant collateral and reduces the risk for lenders.
Myth: HELOCs Don't Have Closing Costs
Don't be fooled into thinking you won't be paying closing costs for your HELOC. While it is true that HELOC closing costs are generally lower than for traditional mortgages or home equity loans, they do exist. HELOC closing costs may include things like appraisal and attorney fees.
Truth: You Can Use HELOC Funds for Various Purposes
Many homeowners believe they can only use HELOCs for home-related expenses. In truth, you can use your HELOC funds for everything from retirement to car purchases. This flexibility is what makes HELOCs so attractive to homeowners.
Myth: HELOCs Always Have Fixed Interest Rates
A common misconception about HELOCs is that their interest rates are always fixed. In reality, most have variable rates, meaning they can fluctuate over time based on market conditions, which can affect your monthly payments and total interest costs.
Truth: Different Lenders Have Different Credit Requirements
It's true that having a high credit score boosts your odds of being approved for a HELOC, but what counts as a good score depends on the vendor in question. Some require excellent scores, while others might be okay with a credit score in the 600s.
Looking to Get Approved for a HELOC? We Can Help
If you're a homeowner in the Philadelphia area considering opening a HELOC, it's important to have a team of professionals by your side who can guide you through the process. PFCU offers HELOCs starting at $5,000 with special introductory fixed rates as low as 3.99% APR for the first 12 months.
Ready to get started? Call 215-934-3500 to speak with a PFCU mortgage professional and see what you qualify for.