What is a home equity line of credit and how does it work?

If you currently own a home, you should look into a home equity line of credit. There are a number of reasons why it would make sense for you to take advantage of this product that most major lenders offer.

A HELOC can be as high as 65% of the purchase price of your home or its market value. You can combine the HELOC with your mortgage or apply for it as a standalone product. When the HELOC is combined with your mortgage, the credit limit will increase as you pay off the principal on your home.

Homeowners apply for the HELOC for a number of reasons; some of the most common being for major renovation projects, investments, having an emergency fund, providing for aging parents, or debt consolidation.

The debt consolidation is a big one because the HELOC typically comes with a lower interest rate than your typical loan, especially credit cards. You can use your HELOC to pay off your car loans, credit card debt, or any other debt with a higher interest rate. Once you do this, your debt is more manageable.

With an HELOC, you only pay interest on the amount you use, and most products have options to make interest-only payments. This makes the HELOC especially attractive to investors buying secondary properties that they plan to rent out.

If you are considering a HELOC as a standalone product, then you’ll require 35% down. Investors like this option because they can make interest-only payments and generate a higher profit with whatever they’re charging for rent.

Whether you’re applying for a HELOC combined with a mortgage or as a standalone product, the lender will check your credit score, and you’ll have to provide proof of a stable and sufficient income. Your lender will also want to know how much debt you have.

If you’re considering a HELOC to avoid the mortgage stress test, we have some bad news for you. The stress test still applies. Your lender must ensure you can afford to make your interest payments if the rates rise, especially since the rate is variable.

Aside from the stress test, there are other disadvantages of a HELOC. You have to be disciplined because the high credit limit and low interest rate make it tempting to spend more money. Your home is collateral, so your lender could take possession of your home if you are missing interest payments. A scary one is that your lender can request you pay the full amount at any time!

When it comes time to selecting a lender, shop around. Get an idea for what rates are available and see which lender offers the best product. You may have an established relationship with a major bank already; in this case, it’s worth it to try and negotiate the rate. If you have a good relationship and credit history, they may be open to giving you a better rate, especially if they know you’ve been shopping around.

To see if a home equity line of credit is a good fit for you, book an appointment at your local bank branch!