A home equity line of credit (HELOC) is a line of credit that uses the equity in your home as collateral. The advantage of a home equity line of credit is the convenience and flexibility. You can request a maximum amount to borrow and only spend what you need. The benefit is you only have to pay interest on the amount you spend, not on the entire line of credit. HELOCs are a good option if you need to pay down credit card debt, make home improvements, or pay tuition. HELOCs are useful to fund intermittent needs; however, the line of credit should be managed prudently because they generally have a variable interest rate, which may fluctuate over time accruing additional interest and increasing monthly payments.
In addition to good credit and a solid mortgage payment history, some lenders may require a hefty amount of equity in your home before they will approve a HELOC. In general lenders require a loan-to-value (LTV) ratio of 80% of the current value of your home. The LTV is the difference between your outstanding balance of your mortgage and your home’s current value. Your LTV helps a lender decide on the line of credit amount you can borrow. E.g. Value of home = $500,000. 80% of value of home = $400,000. Outstanding mortgage balance = $300,000. Line of credit amount = $100,000.
• Your debt-to-income ratio will be reviewed by a lender —- ideally it should be around 40% of your gross income.
• You can estimate your debt-to-income ratio with our Debt-to-Income Calculator.
• We recommend obtaining a HELOC that allows you to repay the loan for a period of time after the drawdown period.
It is vital to use extreme scrutiny when borrowing money for a HELOC. Market conditions, neighborhoods, and wear-and-tear on the asset (the house) all play a factor in assessing if this is truly a good and safe idea for a homeowner.
• Learn how much you can afford with our Affordability Calculator.