Homeowners have seen the value of their homes appreciate considerably in recent years. An increase in a home’s value can contribute to an increase in home equity, or the difference between what’s owed on a home and what it’s worth. Home equity, in turn, can be used as the basis for securing a home equity line of credit (HELOC). In fact, during this period of high inflation when people are looking for ways to maximize their budget, a HELOC provides access to funding at a lower interest rate than many other types of loans or credit cards to anyone who has equity in their home.
Typically, HELOCs are variable rate loans that use a borrower’s home as collateral. HELOCs offer the flexibility to use the line as needed, such as for home remodeling projects that may take time to complete. While the most popular use of a HELOC is for home improvement purposes, it also can be a good way to pay for college expenses, weddings, unanticipated expenses, medical bills and even travel.
The flexibility features of a HELOC can be more attractive to some homeowners than a fixed installment loan like a home equity loan that is paid down over time and whose funds can’t be used again. At the same time, some HELOCs with variable interest rates can become more expensive when Fed interest rates increase.
The life of a HELOC covers two timeframes: the draw period and the repayment period. During the draw period, which is how long the account holder has access to the funds on the line of credit, the balance can increase or decrease as funds are drawn or payments are made. The draw period often requires an interest-only payment, with the borrower applying additional funds as they see fit.
The repayment period starts when the draw period ends. During this time, the remaining balance owed on the account moves to a fixed rate so the loan can be fully paid down by the maturity date. The repayment period features a fixed payment which, depending on the amount used on the account, can be quite a bit higher than the minimum interest-only payment during the draw period.
It’s important to note that HELOCs today provide more options for the borrower. For example, many lenders now offer the ability to lock in an interest rate on all or a portion of the balance on a line of credit during the draw period. This can be helpful if a borrower wants to ensure they have a certain amount paid off during a specific timeframe rather than only having the interest only payment as a minimum payment.
To benefit from the full advantages of home equity, consult with a lender or vendor who is knowledgeable about the local housing market and your personal financial situation to help decide which loan option best suits your needs. If your lender decides a HELOC loan is the proper choice, they will order an assessment to determine the valuation of your property, which is a key component of the loan application process. Home valuations determine how much equity you have available.
HELOC monthly payments will vary based on how much has been drawn against the account or line of credit. Lenders should provide specifics on the payment terms and provide examples for the borrower in the term paperwork. For example, if a borrower has a large line of credit with minimal use, they may have an interest only payment that is lower than the minimum payment.
Keep in mind that a HELOC is secured by your home, creating a potential foreclosure scenario if payments can’t be made. If a borrower runs into difficulties making payments, the lender should look to provide other options It may be possible to refinance the loan into a longer-term fixed rate either by home equity, or a mortgage product.
HELOC’s are an excellent tool for homeowners looking to have access to funding for projects over time, or to have funds available for a “just in case” situation. HELOC’s are flexible and allow the ability to access funds as you need them. If you’re interested in a HELOC, consult with your lender to help determine if it’s the right financial fit for your needs.
Anthony Pellegrino is the vice president and consumer direct lending manager for Northwest Bank. Anthony oversees Northwest Bank’s centralized lending team, including the bank’s residential and consumer lending teams within mortgage and home equity loans and lines of credit, credit cards and personal loans.