How a HELOC Can Help You Unlock Your Home’s Equity

If you own a home, you probably appreciate many of the important financial benefits of investing in residential real estate. Along with providing tax breaks, home ownership enables you to grow your net worth through home equity and an increase in your property’s value from improvements you make and market appreciation over time. The stability and predictability of having your own place can also insulate you against rent increases. 

But there is another often-overlooked advantage of home ownership: your home equity is a valuable resource that you can harness to more easily manage large expenses and achieve meaningful life and financial goals. Home equity is defined as the share of your home that you own outright. More specifically, it is the current appraised value of your home minus the debt on your mortgage. A home equity line of credit, or HELOC, is a financial instrument that enables you to capitalize on this ownership stake in your property. A type of revolving credit, a HELOC allows you to borrow a considerable amount of money at a significantly lower rate as compared with other financing options. 

Because your home serves as collateral, a home equity line of credit poses less risk for a lender versus an unsecured loan. Therefore, lenders will typically offer you a more favorable annual percentage rate (APR) for a HELOC compared with other forms of financing, such as a credit card or personal loan. However, it is essential to be comfortable with the level of risk you assume when you borrow against your home’s equity. Critically, a failure to make payments on a HELOC can put a property at risk of foreclosure.

How a home equity line of credit works:

When you are approved for a HELOC, a lender issues you a credit advance with an established limit and variable interest rate. Over the course of time referred to as the draw phase, you can access funds from this credit line as needed up to your set limit. A HELOC functions like a credit card in that it has a replenishable balance. You can spend funds from this credit line, repay them, and then borrow more up to the maximum approved amount. Accordingly, you only pay interest on the amount you borrow, not the entire line of credit allowable.

Draw periods vary across lenders, but they may range from five to 15 years. Most commonly though, the draw phase will occur over ten years. Depending on the lender, there are various ways to access funds from a HELOC, including an online account transfer, cash withdrawal at a branch, account transfer by phone, or by using a debit card or check linked to this account. During the draw phase, you are only required to make interest payments on the money you spend. However, the minimum monthly payment can fluctuate depending on your balance and the current rate environment. 

Once the draw period ends, you begin to pay back both the amount you have used as well as the accrued interest, typically over 10 to 20 years. In addition, you can no longer tap into your line of credit once this repayment period begins.

How to maximize your home equity with a HELOC: 

A home equity line of credit can be leveraged for a multitude of purposes, many of which may help provide you with greater financial security and growth. A HELOC is one of the most popular and affordable ways to finance home renovations. However, you can use the borrowed funds from a home equity line of credit almost any way you see fit. Potential uses for a HELOC include but are not limited to: paying for home improvements or additions; making a down payment on an investment property; covering educational expenses; consolidating high-interest debt; funding a business venture; planning a family vacation; or covering medical bills or emergency expenses. 

Major benefits of using a HELOC to tap into your home equity:

You will pay less for a home equity line of credit versus other forms of financing.

Because the loan is backed by your home, you can often get a significantly lower annual percentage rate (APR) on a HELOC than you could obtain with other financing options. A better rate will save you substantial money with lower monthly payments and less spent on financing charges overall. You may also be able to borrow more money with a HELOC as compared with other loan products.

A HELOC will give you access to a large amount of money over an extended time period while making minimal payments.

During the draw phase of a HELOC, you are only required to make interest payments on the money you borrow. This option can keep your payments low and therefore easier to manage during this timeframe. Just be aware that if you make interest-only payments throughout the draw period, your payments will be substantially higher when the repayment period begins.

You will have flexibility to spend funds as needed and only pay for what you use.

Unlike a home equity loan or personal loan which provides you with a lump sum payment, you can access money from a HELOC as needed in a series of separate withdrawals. Moreover, you can borrow as much from your credit line as you want up to your approved limit or opt not to use it at all. If you do not tap into your HELOC, you will not owe interest on it. 

This flexibility can be helpful if you are planning for expenditures that will require multiple payments over an extended length of time and may be difficult to predict, such as covering college expenses or a contractor’s invoices. It can also make a HELOC a sensible option if you want to have access to cash in an emergency but are not in immediate need of funds.

What makes you eligible for a home equity line of credit?

Typically, lenders require a minimum of 15% to 20% home equity, a solid credit score, steady and sufficient income, and a low debt balance to approve a home equity line of credit. In terms of debt levels, lenders will assess your debt-to-income ratio (DTI), which measures the amount of your monthly income which is dedicated toward outstanding debts. You can determine your DTI by adding up your monthly debt payments and dividing this number by your gross monthly income. Lenders look for a DTI ratio that is no higher than 36%, but a qualifying DTI may be as high as 43% to 50%. 

When it comes to credit scores, a general FICO score of 720-740 or higher will be necessary to obtain the lowest rates on a HELOC. However, you may be approved for a higher-interest line of credit with a score as low as 620 if you have considerable home equity and a low debt-to-income ratio. 

Final considerations to be aware of when considering HELOC:

A home equity line of credit is an affordable and flexible form of financing that provides a powerful way to leverage home ownership into greater financial security, spending power and wealth. However, it is important to keep in mind that a HELOC is not without risk. Most critically, if you default on your loan, the lender can take possession of it through foreclosure. 

It can also be challenging to predict what your payments on a HELOC will be on a long-term basis since the APR you pay is based on the prime rate, which can fluctuate depending on market conditions. In addition, if you pay only the minimum interest payments during the draw phase, you should be prepared that your payments may rise dramatically once the repayment period begins and you must cover both principal and accrued interest. However, you can avoid this possibility by making extra payments toward the principal on your HELOC during the draw period.

How to tap into your home equity with a HELOC from The Police Credit Union:

When you are ready to unlock equity in your home, your credit union can help make it happen. A HELOC from The Police Credit Union can be used for a wide range of expenditures and financial goals, from covering college expenses and paying off high-interest debt, to renovating your home and making a down payment on rental property. Our HELOC features an introductory rate of Prime minus 1.00% for the first 12 months and credit limits from $20,000 to $500,000. Find out how to apply for a HELOC with our enhanced approval process to get you your funds fast at our Home Loan Center.