What Is a Home Equity Line of Credit & How Does It Work?

  • 05 May 2021
  • Posted by kpassman
Home prices in the United States are at an all-time high, but Americans are reluctant to borrow money secured by their house, and balances on home equity lines of credit (HELOCs) continue to fall. Should you avoid taking out a HELOC, or does borrowing against your home make sense? These are the things you need to know before taking out a HELOC.
 
So What Is a HELOC, Anyway?
A HELOC is a revolving form of credit. The bank extends a line of credit to you, and you can use as much or as little as you choose. As you pay off the HELOC, more credit becomes available.
 
However, a HELOC isn’t just a line of credit. It’s also a mortgage against your house. It's also a lien against your house. If you can’t pay back your HELOC, you risk losing your home.
 
What Do I Need to Apply for a HELOC?
To qualify for a HELOC, you need “tappable equity.”
 
“Tappable equity is the amount of home equity that can be borrowed and still leave owners with at least 20 percent equity in their home,” says Odeta Kushi, deputy chief economist at First American.
 
But that isn’t the only thing you need. A good credit score and a low debt-to-income ratio (debts below 45 percent of your monthly income) are also must-haves.
 
“In the early and mid-2000s, we saw a lot of abuses of home equity lines of credit, so lenders have much stricter criteria these days. The documentation and underwriting standards can be very onerous,” says Joel Kan, associate vice president of economic and industry forecasting for the Mortgage Bankers Association.
 
When Is a HELOC a Good Idea?
If you’ve got substantial equity in your home, taking out a HELOC may seem like a good deal. But before you apply for a HELOC, there are two questions to consider: Does a HELOC make financial sense? And are you borrowing for a good reason?

When a HELOC Makes Financial Sense
HELOC balances are at their lowest level in 14 years, but overall household debts are growing. Instead of borrowing against home equity, households are taking out credit card debt, auto loans, and student loans.
 
This means many households are using high-interest debt when they could use low-interest debt.
 
For example, the average interest rate on a credit card is nearly 17 percent, but HELOC interest rates are closer to five percent. Using a HELOC to fund a home remodel makes a lot more sense than buying materials on a high-interest credit card.
 
Good Reasons to Take Out a HELOC
Of course, borrowing against your house could erode your biggest source of wealth (your home equity). To avoid losing the wealth you have stored in your home, it’s important to only use a HELOC for purposes that add value. Some good reasons to take out a HELOC include:
  • Improving your home
  • Consolidating or paying off high-interest debt
  • Covering an emergency
Using a HELOC to buy consumer goods (like appliances, ATVs, cars, or a boat) or to fund a vacation are not advised uses of the equity in your home. It’s better to save for those items rather than take out debt to pay for them.
 
How Does a HELOC Work?
If you have a lot of equity in your house, taking out a HELOC could be a great way to borrow money. But before you take out a new loan, it’s important to understand the risks associated with HELOC borrowing. These are the most important things to know.
 
Your House Is on the Line
One of the biggest risks associated with a HELOC is that you could lose your home. If you lose your job, and you can’t make the payments on your HELOC, you’ll have to work with your lender to avoid foreclosure.
 
Depending on how much you’ve borrowed, keeping your house could become difficult.
 
 “If there’s ever a distress situation, it’s always easier to help someone who isn’t in a tight equity situation,” Kan says.

A HELOC Isn’t Free Money
One of the most important facets of a HELOC is that it isn’t free money — it has to be paid back. Overborrowing on a HELOC means that a small decline in property values could trap you in a house with negative equity.
 
During the recession from 2007 to 2009, many people found that out the hard way.
 
Tom and Tonya of North Carolina used a HELOC on their former home in Virginia to help their children pay for college. Unfortunately, their house value dropped in the housing crisis.
 
Between their mortgage and the HELOC, the couple owed more than the house was worth.
 
When the couple decided to move to North Carolina in 2014, they were still trapped with negative equity. To cover their payments, they had to convert their home into a rental property. Today, the rental income barely covers payments on both mortgages, and selling the house would just barely pay off both the mortgage and the HELOC.
 
How Much Can I Borrow?
The amount you can borrow depends on your home equity levels, your credit score, and your income. Lenders usually require at least a 20 percent equity cushion, according to Kushi. That means if your house is worth $250,000, and your primary mortgage is $150,000, your maximum line of credit would be $50,000.
 

What Will My Payments Be?
When you first take out a HELOC, ask your lender about the monthly payments, but be aware the monthly payments may change over time. Because HELOCs are generally variable rates based on a rate index (such as the Prime Rate), the interest rate (and the corresponding monthly payment) could increase over time, even if you don’t borrow more. 
 
Is a HELOC a Good Idea for Me?
Before you decide to take out a HELOC, it’s important to consider all your options. Could you find a better interest rate? Perhaps using a zero-percent credit card could help you pay off an expensive medical bill. Or does it make more sense to save up money rather than borrow? If you’re looking to buy a snowmobile, it makes more sense to save up and pay for it with cash.
 
If a HELOC is your best option, compare rates and terms to be sure that you’re taking out the best one for you. To learn more about Howard Bank's home equity options, click here.
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5 Myths Busted About Home Equity Lines of Credit

  • 09 Nov 2018
  • Posted by kpassman

It’s funny how sometimes a myth can be taken as fact if it’s repeated often enough. It can even gain “conventional wisdom” status.

Sometimes it doesn’t matter much. It’s pretty harmless to think a tooth will dissolve overnight in a glass of Coca-Cola, and it may do some good if it keeps you away from the sugary drinks. But believing banking myths can hurt your personal finances – and there’s nothing good about that.

For example, a number of myths swirl around home equity lines of credit (HELOCs), and many of these misrepresent what is actually a safe and secure way to borrow money. With a HELOC, you can access a line of low-interest credit secured by your home’s equity – much like you would with a credit card, only the interest rate is usually much lower than credit card rates.

So today we want to take a few minutes to bust a few HELOC myths – and let you know the truth…

Myth No. 1: You Can Only Use a HELOC to Pay for Home Improvements

It’s true that HELOCs were initially created with home improvements in mind. However, the fact is that you are allowed to use your HELOC to pay for just about anything – from debt consolidation to your children’s college tuition. That said, most advisors think homeowners should use their HELOCs for expenses that add value to your finances. For a list of our own suggestions, click here.

Myth No. 2: A HELOC and a Home Equity Loan Are the Same Thing

With a home equity loan, your lender will provide you with a one-time lump sum. You pay that fixed-interest loan off over time, month by month. With a HELOC, however, the bank extends to you a line of credit that you can draw upon whenever and as often as you like, within your draw period. While the interest rate is generally low (much lower than that of a credit card), it fluctuates along with the prevailing rate.

Myth No. 3: A HELOC Will Hurt Your Credit Score

On its own, a HELOC should not affect your credit score. It shows up to credit scorers no differently than a credit card. But just as with any other debt you incur, late payments on your loan or maxing out your HELOC may affect your credit score. It’s wise to ensure that you do not advance your line over the approved credit limit as this also would reflect on your credit report.

Myth No. 4: You Can Pay Off Your HELOC by Making Minimum Monthly Payments

With most HELOCs, if you make only the minimum payment each month, you’ll only cover the interest. Once the “draw period” – the five to 15-year stretch of time when you can use your HELOC – ends, the principal starts becoming due. Depending on how much you’ve used, that can be a lot of money. So the best strategy, much like with a traditional credit card, is to make much more than the minimum payment each month.

Myth No. 5: HELOCs Are Difficult to Get

Because banks are more stringent with making HELOC loans than they were before the financial crisis, many consumers assume they’re impossible to get. The fact is, however, many current homeowners can qualify for a HELOC. Banks are tougher than they used to be, but they’re still making many, many loans of all sorts to qualified customers. Plus, you can apply for a HELOC nearly immediately after you buy your home.

Taking out a HELOC is not risk-free. But if you use your HELOC conservatively and pay more than the minimum due each month, it is among the best loan options out there. 

If you’re ready to apply for a HELOC, or for more information, please contact us

Written by Kathy Passman
Kathy Passman is the Vice President, Consumer Lending Manager at Howard Bank. She 
has lead the Consumer Lending Department since 2012 and holds over 20 years of experience in the industry. 

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Should You Use Your Home Equity Line of Credit For That?

  • 08 Nov 2018
  • Posted by kpassman

We’ve all heard the stories about people, before the 2008-’09 financial crisis, using their homes as “ATMs.” I’m talking about homeowners using the equity in their homes to pay for luxuries – jewelry, vacations, even cosmetic surgery.

That’s poor financial management, and a lot of those folks got themselves in real trouble. Today, most homeowners seem to have learned that lesson. Instead, when homeowners do take out a HELOC, it's often being used solely as an emergency fund.

But this approach may not be the wisest choice for your money, either. There is, in fact, a middle ground between abusing the credit your home equity affords you and using it wisely.

What Is a HELOC?

A HELOC is different from a home equity loan, in which you get a lump sum amount, then pay it back according to a schedule. A HELOC makes a percentage of your home’s value available for five to 15 years, and its interest rate adjusts with the market. When it expires, you only pay for what you’ve used – then it disappears with no additional expenses.

Any loan or line of credit carries some risk, and a HELOC, for which you use your home as collateral, is no different. But if you are savvy and conservative, a HELOC is a safe and secure way to pay for a number of life’s major expenses. Let’s take a look at a few of them…

College Tuition

Because the interest rates could be lower than those on student loans, using a HELOC to pay parts of your child’s college tuition could be a good option. Compare interest rates and closing costs to see if a student loan or a HELOC is cheaper for you.

Home Improvements

HELOCs were designed to be used for home repairs and renovations. And that’s still the primary reason homeowners take them out. However, we recommend you use a HELOC primarily on improvements that increase a home’s value. That way, any interest you pay will return to you when you sell your home.

A HELOC is also good for financing essential repairs that may not raise the value of your home but will upgrade its safety and/or structural integrity. In this case, I’m talking about fixing a leaking roof or replacing faulty wiring.

For other home improvements, such as interior design and landscaping, tap your cash savings (though not your emergency fund). Or, put it on your credit card and pay it off at the end of the month. That way you can ensure the equipment you buy – and pick up some points.

Emergency Fund

Everyone should keep an emergency fund to cover unexpected health bills, car repairs, and home repairs. Where you keep that emergency fund depends on your situation and financial philosophy. Some people believe that any money that isn’t “working for them” is useless. They keep their emergency fund in an easily accessible interest-paying savings account.

However, the interest rates on savings accounts are pretty measly these days. And so, you might be better off piling most of your cash into a stock market index fund. It’s not very sexy, but it earns more than a savings account. Then, use your HELOC as your emergency fund.

Consolidating Debt

Besides what you pay off at the end of every month, do you have any credit card debt? If so, get rid of it. Use your cash to pay off what you can, and then pay down as much as you can of the rest using a HELOC. Home equity lines of credit charge much less interest than credit cards, so you’ll be saving money. Plus, unpaid credit cards hurt your credit score and, therefore, your chances of getting loans in the future.

If you consolidate debt using a HELOC, you’ll get out of debt faster thanks to those lower interest rates. Plus, you’ll essentially be paying yourself rather than Visa or MasterCard.

If you’re ready to apply for a HELOC, or to talk more about the best ways to use a HELOC you already have, please contact us.

Written by Kathy Passman
Kathy Passman is the Vice President, Consumer Lending Manager at Howard Bank. She 
has lead the Consumer Lending Department since 2012 and holds over 20 years of experience in the industry. 

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What's a Good Use for a HELOC?

  • 22 Jun 2017
  • Posted by Amarasco

When you take out a second mortgage, a name for a home equity line of credit, you're offering your house as collateral to secure another loan. The upside: You can gain access to up to 85% of your home's value, minus your current mortgage balance and adjusted based on your creditworthiness. The downside? If you can't make your payments, you could lose where you live. Because the stakes are high, you want to make sure you use a HELOC for the right reasons. Here are a few.

Making home improvements

Most people who take out a HELOC do so to make home improvements. Experts say you should only do this if the improvements you're considering will increase your home's value. This way, the money you're borrowing will be returned when you sell your house at a higher price. The National Association of Realtors' 2015 Remodeling Impact Report lists these six changes as the ones with the best return on investment:

  • Installing a new front door.
  • Installing new siding.
  • Upgrading your kitchen.
  • Adding on to your deck and patio.
  • Making an attic into a bedroom.
  • Installing a new garage door.

These improvements can range from a few hundred to tens of thousands of dollars, but they don't change the footprint of your home and tend to be what future buyers look for.

Supplementing an emergency fund

Everyone should have an emergency fund to cover events such as unexpected car repairs and appliance breakdowns. Most people keep these in savings accounts, but you might consider a home equity line of credit as another source of cash. You only pay interest on the amount you borrow, and you could pay the loan off quickly to save money. Still, it makes more sense to have an emergency fund that's earning a little interest rather than one that charges you interest.

Paying off high-interest debt

Because the average interest rate on a HELOC is much lower than the average credit card interest rate, many people think about using a HELOC to pay off their credit cards. This is a great strategy if you're committed to never carrying a balance again. Otherwise, you're just adding another debt at a lower rate. Regardless of how you use a HELOC, remember that the interest rate is variable and may change each time you tap it. And you'll have to repay the entire loan by the end of the payment period set by the lender. On the upside, the interest you pay on a HELOC is tax-deductible, like your mortgage interest. If you use a HELOC for the right reason, that's just one more benefit. © Copyright 2016 NerdWallet, Inc. All Rights Reserved

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Best Ways to Fund Spring Home Repairs

  • 17 May 2017
  • Posted by Amarasco
Now that spring has blossomed into full-on allergy mode, the time we spend outside is even more appreciated — especially with the help of a good antihistamine. The next time you venture out, take a moment to do a walk-around inspection of the old homestead. See some room for improvements? Maintaining, repairing and upgrading a home can range in cost from a minor trickle to a major cash drain.

Paying for minor repairs

If you see the need for only modest repairs, you might be able to tackle them within the bounds of your cash flow. But remember, your emergency fund is best left intact for unexpected cash needs, not for replacing a gutter or downspout. If you have a bit of a cash cushion in your checking account or in a contingency savings account, small home projects can be covered with your close-at-hand liquidity, even if it means a temporary trim to discretionary spending, such as a couple of “family nights out” spent at home.

If the need exceeds the cash

If your home-repair needs are more costly, you might consider turning to your secondary tier of financial resources: a credit card. While average credit card interest rates are in the double digits, you can do a lot better, particularly with introductory rates that can last more than a year. When it comes to minor improvements or repairs, having that extra spending power available will allow you to fix what’s needed now, while budgeting the repayment over a period of time. It’s best to keep that payback schedule from extending longer than three to six months. If you need to spread the payments out beyond that, you might protect your credit score — and pay less interest — by considering our next funding alternative.

Raising the roof on expenses

Larger home upgrades or repairs are going to require bigger investments. A new roof, exterior painting, foundation repairs or other projects will protect your home’s value — and can end up costing more the longer you delay. Under these circumstances, a loan often can get you more than your credit card limit will allow, as well as save you money. A secured loan will offer a better rate than an unsecured loan, while both likely will offer much better long-term interest rates than a credit card. Longer repayment terms will be favorable for these larger projects, too.

Covering the cost of major upgrades

Your strolling inspection — in, around and outside your home — might have revealed a need for a major upgrade. Perhaps the furnace has heaved its last gasp, or the air conditioning is already struggling with the warmer spring weather. Or it might be time to do a bit of renovation to a bath or kitchen that is well past its “best by” date. In that case, it might be well worth tapping a home equity line of credit, or HELOC. Accessing the value of your home — up to 100% of your existing equity — will allow you even greater financial flexibility. Once approved for an open-ended revolving credit line, you can draw from it at any time, as needed. And you’ll pay interest only on the balance you’ve withdrawn. Not only are the variable rates very favorable on HELOCs, but the interest paid may be tax-deductible. Your tax advisor can give you details on that. And repayment terms can stretch as long as 15 years, depending on the amount financed. From a small repair to a major improvement, there are prudent ways to fund whatever spring home project you decide to undertake. © Copyright 2016 NerdWallet, Inc. All Rights Reserved

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