They say home is where the heart is – it may be where the smart borrowing is, too! If you've lived in your home for a while, you may have equity built up that can help you manage your finances. If you have a large purchase or expense on the horizon, you'd like to upgrade your home, or you’d like to manage debt better, a HELOC could be right for you.
For starters, a home equity line of credit (HELOC) is a credit line established against the equity in your home, and it allows you to borrow as needed. In other words, it is a line of credit in which the lender agrees to lend a maximum amount within an agreed period of time, where the collateral is the borrower's equity in his/her house.
But why should you use a HELOC over other home loans, like a fixed home equity loan? Let’s take a closer look at when you should consider applying for a HELOC over other loan types.
There are all sorts of benefits to using a HELOC, but in some cases a home equity loan may be better. In any case, current home equity rates for both make it possible to borrow money with lower rates (much, much lower!) compared to credit cards, so you can save money in the long run. Let’s decide on what’s best for you, a fixed home equity loan or HELOC.
HELOCs are attractive for many homeowners because interest rates are typically lower than other loans, and the interest paid may be tax deductible.* HELOC borrowers also have more flexibility around repayment than with a fixed loan.
* Check with your tax advisor regarding tax deductibility in your situation.
If you’re looking for an option in-between the two, a Hanscom Home Equity Plan combines the predictability of a fixed-rate loan with the flexibility of a line of credit. Plus, you can designate a portion of your line as a Platinum Mastercard® for even greater convenience.
To qualify for a HELOC, you will have to show that you have available equity in your home. Lenders commonly restrict borrowing amounts to 85 percent of the home’s appraised value minus any mortgage(s) on the home.
You will also need to show that you meet the debt-to-income ratio required by your lender. This percentage indicates what part of your monthly income is taken up by your monthly debt payments. Start by adding up your monthly payments, including your mortgage, auto loan or lease, credit cards, other personal loan payments, and your projected home equity payment. Take the total of those payments and divide it by your current monthly income before taxes. The result is your debt-to-income ratio. Most lenders require this number to be no higher than 36 percent.
Finally, review your credit report to understand your credit score and correct any misinformation. Lenders will use your score to determine your creditworthiness.
So who should avoid getting a HELOC? Anyone who finds themselves in any of the following situations:
Taking out a HELOC can be expensive depending on the lender. In some cases there may be hundreds of dollars of out-of-pocket costs, just like you had when you took out your first mortgage. These include fees for your application, title search, appraisal and attorney, in addition to any points you may have to pay.
That doesn’t mean you can’t find a loan with similar benefits with lower upfront costs, and there are plenty of options available to you. Do some research and find the best fit for your situation.
If you think there’s a possibility your income will change for the worse at any point during the loan, then a HELOC is a bad idea. If you were to find yourself short of cash and couldn’t make your monthly payments, your lender could force you out of your home.
The other possibility is that your financial situation worsens and your lender decides to cut off your access to the line of credit. You wouldn’t lose your home, but your HELOC would be closed.
If your HELOC has a lot of upfront costs and you only want to take out a few thousand dollars, it probably isn’t worth it. (In this case, you’re far better off with a low-interest credit card.) Also, many financial institutions have minimum draws for their HELOCs, so check out the specifics before signing on the dotted line.
Unless you have a fixed-rate HELOC, you need to be prepared for interest rates to rise over the course of the loan. All adjustable-rate loans have lifetime caps that set the maximum interest rate, so even though your interest rate may not ever get to its highest point, be aware that it’s a possibility and what that would do to your monthly payment.
A deed of entrust, including your home equity loan or HELOC, is recorded for public record upon closing a loan, which means absolutely anyone – including a scam artist – can take a look at that record at your town hall. They can find out how much you borrowed and glean other personal information they can then use to rip you off.
Since a home equity loan or HELOC represents a large chunk of money, it's important to safeguard it from crooks. We’ll go over some actions and things to keep in mind so that you can better protect yourself from these scam artists.
Be wary of anyone that comes knocking on your door, especially after you've received a home equity loan or HELOC, and says something like, “I was driving by and couldn’t help but notice your driveway needs work." Too often, such people want a cash down payment — now — then vanish. Keep in mind, too, that in-demand contractors simply don't have the time to scout around neighborhoods looking for work. In fact, the opposite is usually true: you have to wait until they can fit you into a packed schedule.
Even if they show up to work, unscrupulous "contractors" will overcharge you, perform unnecessary or substandard work, use inferior or inadequate products, and in many instances, fail to perform any of the work specified and paid for in the contracts. Follow standard best practices when contracting any kind of work on your home, whether or not you have a home equity loan, HELOC, or if you're self-funding the project:
Not every contractor with a sales pitch is out to scam you, but many are, so you need to be on guard. If they seem legit and it's a renovation that's been on your list, check their references thoroughly and contact the Better Business Bureau to see what other customers have to say.
A new roof or driveway can be yours at a deep discount if, and only if, you sign the contract right now or pay a cash deposit today. But remember: a conscientious, reputable contractor will never badger or pressure a potential customer this way or deeply discount a quality job backed by years of experience.
Look for referrals from neighbors, friends, your social media network, and family for specific projects for which you've already planned. Were their contractors dependable? Did they perform the work as contracted? If any problems arose, were they dealt with promptly and professionally? Has the quality of work held up over time?
Always ask for a contractor license number and check it with your state's licensing board to ensure it's current. Also ask to see identification and insurance coverage. If they can't show you this information, move on.
And get them in writing. These estimates should include as much detail as possible, especially prices, specific materials/products to be used, and a timeline for the project's completion. You've worked hard to build equity in your home; be sure to use it wisely.
Ultimately, you will have to choose whichever option best suits your situation, be it HELOC, fixed home equity loan, a combination of the two, or something else altogether. Take a look at your budget and think about how much money you’ll need to borrow, and whether or not it makes sense to borrow-as-you-go or to have a fixed amount with unchanging rates to pull from.
If you want to learn about HELOCs or other home loan options, check out our Home Equity Edge guide.
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