Home Equity Line of Credit

By Bill Lyons | Published on June 27, 2023

Leveraging the equity you’ve built up in your home can help you pay for large expenses at a lower interest rate than other types of debt like personal loans or credit cards.

A home equity line of credit (HELOC) is a second mortgage that allows you to start using your home’s equity to increase cash flow and access capital that helps you pay for major expenses or grow your wealth.

Your house is one of your most significant assets, but your house isn’t liquid. A HELOC can help you access cash when you need it most by borrowing against your home’s equity. But is a home equity line of credit the right option for you? Keep reading to learn more about HELOC loans and how they work.

What Is a Home Equity Line of Credit (HELOC)?

A home equity line of credit allows homeowners to borrow against their home equity and receive the funds as a line of credit rather than a lump sum like other types of loans. Unlike your first mortgage, your HELOC loan can be used for anything, including paying off debts, making large purchases, home improvements, and so forth.

Home equity lines of credit are second mortgages, so they don’t replace your existing mortgage like a refinance. Instead, you’ll have two home loans: one for your property and the other that allows you to access cash based on the current market value of your home.

If you own your home and don’t have an existing mortgage, a HELOC loan will become your primary mortgage, in which your collateral is the property.

How Does a HELOC Work?

A HELOC loan isn’t the only way to borrow against the equity in your home, so how does a HELOC loan work compared to other types of loans? Think of your home equity line of credit like a credit card. You’ll be able to pull funds and repay them on a monthly basis.

Your home equity is the difference between the home’s value and the amount you owe on your mortgage. As you repay your HELOC balance, the amount of credit you have available is replenished for a certain period of time, so you can continue to borrow against your equity time and time again as long as you can repay the balance.

At the end of the draw period, the loan term, you’ll have a repayment period that allows you to pay off your existing HELOC debt without penalty.

Most home equity line of credit loans have adjustable interest rates, which means your interest rate will fluctuate depending on market conditions. However, interest rates for HELOC loans are typically much lower than other forms of debt, such as personal loans or credit cards, so even if your interest rate increases based on current market conditions, it’s still much more affordable than using your credit card for major purchases.

You can use your home equity line of credit as many types as you want throughout the draw period and pay off your debt to replenish the amount available to you. However, while there’s a set repayment period, you’ll be responsible for monthly payments, which are typically interest only during the draw period.

Then, during the repayment period, you’ll continue to pay back the principal and interest of the loan monthly.

How much can you borrow with a HELOC?

How much you can borrow with a home equity line of credit depends on your home’s current value and how much of your mortgage you owe—your equity. Lenders typically only allow you to borrow up to a certain percentage of your existing equity, so you won’t be able to access all of it.

Since loan limits vary, you’ll need to do your research and speak to a lender to determine your loan amount. First, the lender will have an appraiser determine your home’s current value based on its size, condition, and comparable sales in the area. Then, they’ll subtract your existing mortgage debt from the appraised value.

Most lenders allow you to borrow up to 80% of your equity, but it may depend on your credit score. The better your score, the more you may be able to borrow. Your maximum amount is determined by several factors, such as:

• Credit score: The higher your credit score, the better your loan terms. Additionally, a higher score may mean you’re able to borrow more.
• Interest rate: Higher interest rates can limit your borrowing potential. A higher interest rate directly results in higher monthly payments, which may mean you can’t borrow as much. However, a lower rate means a lower monthly payment, allowing you to access more of your equity by borrowing more.
• Debt-to-income ratio: To determine if you qualify and your loan amount, lenders will compare your existing debts to your income to ensure you can afford the monthly payment, especially when the interest rate fluctuates.

Home Equity Line of Credit vs. Home Equity Loan

As we’ve mentioned, there’s more than one way to take advantage of your home’s equity. Besides a home equity line of credit, you may also choose a home equity loan. While these two home loans sound the same, they have a few key differences in how you receive the funds and interest rates.

What is a home equity loan?

Like a HELOC loan, a home equity loan is a type of second mortgage you can use to access the equity in your home. However, unlike a HELOC loan, you’ll receive the funds in one lump sum and pay it back in monthly installments, similar to how your primary mortgage works.

With a home equity loan, the monthly mortgage payments have a fixed interest rate, so you’ll know exactly how much you owe every month for the life of the loan. When comparing HELOC vs. home equity loans, you should consider whether you prefer fixed or variable interest rates and whether you’ll need a revolving line of credit.

How does a home equity loan work?

Similar to a HELOC loan, a home equity loan can be used for anything and is secured by the property; if you fail to repay the loan, you could lose your home. Once you repay a home equity loan, you can no longer access your equity; it’s not a revolving line of credit like a HELOC loan. In addition, you’ll pay interest on the total loan amount, not just on the amount you used.

HELOC vs. Cash-Out Refinance

Another option for accessing your home’s equity is a cash-out refinance. With a cash-out refinance, you replace your primary home loan with a new one, so it’s not a second mortgage. By replacing your old loan with a new loan with a larger amount, the difference between the original amount and the new loan is given to you in a lump sum.

How much cash you get depends on your home equity, and lenders typically require you to have at least 20% equity in your home before you qualify for a cash-out refinance, so you can borrow up to 80% of your home’s value or as much as you need. However, these guidelines vary by lender. For instance, eligible borrowers can take out a loan for up to 100% with a VA cash-out refinance.

A cash-out refinance is typically best for individuals who prefer a fixed payment or a lower mortgage rate. Many people refinance their homes to reduce their interest rates, ultimately decreasing their monthly payments. However, the cash-out refinance is a bit different. In most cases, you’re not refinancing to lower your monthly payments but instead refinancing to increase your cash flow, even though it means potentially higher monthly payments.

Since these loans replace your existing mortgage with a new one, they can be more affordable than a second mortgage. However, you may prefer a HELOC loan if you’re looking for more flexibility when accessing your equity.

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HELOC Loan Qualification Requirements

Qualifying for a HELOC loan is similar to qualifying for a mortgage. You’ve already been through the mortgage process once, so it shouldn’t be too complicated. However, there are still several qualification requirements you must meet to qualify for this type of second mortgage.

Requirements tend to vary by lender, but in general, you’ll need the following:

• Equity amount: To qualify for a HELOC loan, you’ll need to have a certain amount of equity in the home. Most lenders require you to have at least 20% equity before you qualify. There are limits regardless of your equity amount, so you should try to build up as much equity as possible before applying for a loan if you need to borrow a large amount.
• Income: For any loan, lenders must verify your income to ensure you can repay the loan. Having a reliable source of income is especially crucial for any type of mortgage loan — primary or secondary — because it demonstrates that you can afford to pay your monthly bill.
• Credit score: Most lenders prefer you have a credit score in the mid to high 600s to qualify for a HELOC loan because it demonstrates your trustworthiness. However, the exact credit score requirement varies by lender. You should always try to increase your credit score before applying for a home equity line of credit because it will impact your eligibility and loan amount.
• Credit history: While your credit score is a reflection of your credit history, most lenders prefer to know that you have a history of paying your debts on time, so they’ll look at your credit history. If you’re applying for a home equity line of credit from the same lender as your existing mortgage, you’ll have already proved your credit history if you’ve paid your monthly mortgage premium on time every month, which increases your chances of getting approved for a loan.
• Debt-to-income (DTI) ratio: Your DTI ratio calculates what percentage of your gross (pre-tax) income goes toward paying monthly debts, including your existing mortgage, credit card, and loan payments. Most lenders look for a DTI of no more than 43%, which indicates that only 43% of your income goes toward paying your debts. However, the lower your DTI, the more likely you are to get approval.

Benefits of a HELOC

The most significant benefit of a HELOC loan is that you can borrow against your home’s equity to increase your cash flow, allowing you to consolidate debt, pay for home improvements, or invest to grow your wealth. Other benefits of a home equity line of credit include the following:

• Flexibility: You can use your HELOC loan to pay for anything, whether it’s your child’s college tuition, medical bills, or to invest in stocks. There are no restrictions on how you use your home’s equity.
• Borrow as much as you need: A home equity line of credit replenishes throughout the draw period as you pay off your outstanding balance, allowing you to access as much cash as you need.
• Tax deductible for home improvements: If you use a HELOC loan for home improvements, your interest may be tax-deductible. However, your interest is not tax deductible if you use the loan for anything else.
• Lower interest rates: Mortgage loans typically come with lower interest rates than other types of loans and debt, like personal, auto, and business loans, as well as credit cards. These lower interest rates result in less spent over the life of the loan.
• Only repay what you spend: With a HELOC loan, you’ll only pay interest on what you actually spend. Meanwhile, with other types of loans, you’ll repay the total loan amount plus interest, so HELOC loans may actually be more affordable, depending on your unique circumstances.
• Can convert to fixed-rate loan: Before the end of the draw period, you can convert your HELOC loan into a fixed-rate loan, which can make monthly payments more manageable.
• Flexible repayments: You don’t have to wait for the draw period to end to begin repaying your HELOC loan. Instead, you can begin repaying during the draw period to reduce the amount you’ll owe in interest.
• May increase credit score: Many people use HELOC loans to pay off or consolidate existing debts, which can drastically increase your credit score within a short amount of time.

Drawbacks of a HELOC

A HELOC loan is a second mortgage, which means your house is your collateral. If you fail to repay your loan,

you may risk foreclosure. Other drawbacks of a home equity line of credit include the following:

• Variable interest rates: HELOC loans have variable interest rates that fluctuate depending on market conditions. Your rate can increase, so even if you get a loan with a low rate, you could have much higher interest rates in the future.
• Potential for overspending: Some people don’t engage in good spending habits. Since HELOC payments are interest-only during the draw period, it’s easier to access cash without considering the total costs associated with the loan. If you’re continuously drawing funds, your payments can increase to the point where it may become impossible to manage your debt at the end of the draw period.
• Reduced equity: When you take out a home equity line of credit, you effectively reduce the amount of equity you have in your home. If home prices decrease and you want to sell your home, you may end up owing more on your mortgages than the home is actually worth.

Is Getting a HELOC Loan a Good Idea?

A home equity line of credit can be a useful tool for accessing your home equity, but it’s not the right option for everyone. Whether this loan is right for you depends on your financial situation, how you’ll use your funds, and whether you can afford to repay the loan.

Ultimately, some loans may have better rates, and a home equity line of credit might not be right for you if you’re planning to move in the near future. As a homeowner, you have many options for tapping into your equity, including HELOC loans, home equity loans, reverse mortgages, and cash-out refinances. The best option for you will significantly depend on your financial situation and goals.

For instance, if you’re someone who prefers to know what their monthly payments will be throughout the life of the loan, you may prefer a home equity loan instead of a HELOC loan because it has fixed interest rates. However, if you’re unsure exactly how much cash you need, you may prefer a HELOC loan because it’s a revolving line of credit.

A home equity line of credit might be right for you if:

• You have home equity: You should have at least 20% equity in your home before applying for a HELOC loan
• You have good credit: You must have a history of paying your debts on time to qualify for a home equity loan. Lenders will also look at your credit score and typically require a mid-600 credit score to qualify.
• You have a low DTI ratio: If you have a relatively low DTI ratio, it means you don’t have a lot of existing debt, so lenders will be more willing to approve your loan.
• You want to pay for multiple things: A HELOC loan can be used for a variety of reasons, ranging from paying off debt to investing. Ultimately, you can use your loan for anything and everything.
• You’re unsure of the exact amount you need to borrow: Since HELOC loans are revolving lines of credit, you don’t need to know the exact amount you should borrow. Instead, you’ll be approved for around 80% of your equity, and you’ll only pay interest on what you use.

If you’re unsure which type of loan is best for your unique situation, you can contact Griffin Funding. We can learn more about your unique situation and goals to find the best way to tap into your home equity and increase your cash flow.

How to Get a HELOC Loan

Getting a HELOC loan is similar to applying for any other type of home loan. Your lender will ask for the same types of documentation to verify your income, assets, reserves, and debts. The simple process for getting a HELOC loan is as follows:

1. Calculate equity

The easiest way to calculate equity in your home is to subtract your mortgage debt from your home’s appraised value. If you don’t want to hire your own appraiser, you can review comparable properties in the area that have recently sold, which should give you a general idea of how much equity you have. Your lender will hire an appraiser to determine your home’s true market value before calculating your loan amount.

Once you have a general idea of how much equity you have, you can multiply that amount by 80% (0.80) to determine how much you’ll be able to borrow. Some lenders will allow up to 95% in some cases, leaving as little as 5% in equity in the home.

2. Find a lender

Most mortgage lenders and banks offer home equity lines of credit, so you can use your existing mortgage lender to make the process a little easier. They already have records of your existing mortgage payments, which should give them the confidence to give you a loan. If, for some reason, your current lender doesn’t offer HELOC loans, you can find a new lender by searching for one online and reading their reviews to ensure they’re trustworthy.

3. Gather your documentation and apply

You’ll need the same documentation for a HELOC loan that you needed for your primary mortgage, which may include pay stubs, tax returns, bank statements, and other assets. If you’re unsure what you need, you can contact your lender before starting the application to ensure you can submit everything at the same time.

4. Go through underwriting

After you’ve submitted your application, you’ll go through the underwriting process in which the lender verifies your information and determines whether you qualify for a HELOC loan and the loan amount. Throughout this process, the lender may contact you for more information and documentation to ensure they completely understand your financial situation. We recommend responding to their inquiries as soon as possible to help streamline the process.

5. Closing

After your application has been approved, you’ll set a date for closing, where you’ll sign the paperwork and finalize the loan.

See If a Home Equity Line of Credit Is Right for You

A home equity line of credit allows you to leverage your equity and increase cash flow to make major purchases, invest in home improvements, and pay off debt. But is a HELOC loan right for you?

Contact Griffin Funding today to learn more about HELOC loans and other options for accessing your equity.

Bill Lyons

Bill Lyons is the Founder, CEO & President of Griffin Funding. Founded in 2013, Griffin Funding is a national boutique mortgage lender focusing on delivering 5-star service to its clients. Mr. Lyons has 22 years of experience in the mortgage business. Lyons is seen as an industry leader and expert in real estate finance. Lyons has been featured in Forbes, Inc., Wall Street Journal, HousingWire, and more. As a member of the Mortgage Bankers Association, Lyons is able to keep up with important changes in the industry to deliver the most value to Griffin's clients. Under Lyons' leadership, Griffin Funding has made the Inc. 5000 fastest-growing companies list five times in its 10 years in business.