A big house or apartment is always a great idea! For example, a large-scale renovation! But where to find the money to implement these plans? Taking a consumer loan in this case may not be appropriate. Therefore, many think about the HELOC (or HELOAN) loan — however, there are many concerns. Let's try to answer the question: is HELOC in 2023 a good idea?

What is HELOC?

Let's start with the basics. Home equity loan is the difference between the market price of your property and the outstanding loan for it. If you've been a property owner for a while, your home likely has home equity. Under it, banks are ready to give loans! It is essentially a mortgage on your property (or the portion of the value of that property that you have paid). These loans are a second mortgage and in case of default, the borrower will face foreclosure process and loss of property.

How does the credit line work? 

Home equity lines of credit differ from traditional loans in that the borrower does not receive the full amount at once. He is given a so-called credit line — you can use it at any pace, without exceeding the credit limit. The idea is very similar to how a credit card works. Payments are usually the amount drawn from the line of credit plus interest. The line can be set up with a monthly payment system in which most of the payments go towards paying interest, but the borrower can, if desired, deposit any amount over the minimum payment. Lenders typically allow you to borrow up to 85% of your home's appraised value, minus the amount you still have to pay for a conventional mortgage. Many HELOCs have a fixed term. During this period, you can borrow, and at the end of it you can repay the loan.  Your HELOC credit limit also depends on how much home equity you have in your home. There is a ‘draw’ period — typically five to 10 years, during which you have access to the funds in your credit line. Then comes the ‘repayment period’ — typically 10 to 20 years, when you can no longer get the money. But still must return any outstanding balance with interest.

Benefits of a home equity line of credit

  • Taking out a home equity line of credit for debt consolidation can significantly reduce the cost of your loan.
  • Lower interest rates that are usually very close to the prime rate.
  • An affordable way to get financing for short-term needs.
  • Easy access to funds.
  • HELOC can act as a contingency fund.

Disadvantages

  • The collateral on the line of credit is still your home, so if you can't make payments, you risk losing your home. There is always such a risk.
  • Repayment flexibility and easy access to funds can be dangerous for borrowers who are not accustomed to such responsibilities.
  • Because of the ease of increasing your credit limit, it's very easy to get caught up in a cycle of debt.
  • HELOC forces you to rely on credit rather than increasing your savings.

Purpose of obtaining HELOC

Goals can be almost anything. This is not necessarily a property renovation. And, for example, buying a second home, paying off credit cards, paying for education, unexpected expenses, and emergencies.

On what basis is a loan issued?

The amount of HELOC depends on a large number of factors. And the more plus signs you put, the higher the amount of your loan will be.

What is taken into account when issuing HELOC:

  • credit history
  • income
  • liabilities for loans and other payments
  • the value of the property and your paid share
The last point is worth explaining in more detail. For example, you own a house that is worth $300,000 today. Yes, this is an important point, it does not matter to the bank whether you bought it for $200,000 or $600,000. The appraisal will evaluate the property today. Let's say you have $100,000 left to pay back to the bank (the remaining mortgage). Thus, home equity equals $200,000. However, the bank will not give you all $200,000, but will also take into account LTV. LTV (loan-to-value) — expressed as a percentage. It can be 75, 80, 90% and depends on several factors:
  • bank and its policy
  • is this property a permanent residence?
  • your debts on other loans
  • income and other factors
Let's say you get an LTV of 80%. Thus, we have the following calculations: $300,000x0.8 = $240,000 (using LTV here) $240,000-$100,000 = $140,000 (subtract remaining outstanding mortgage). So, you can borrow $140,000 for your property.

Interest rate 

The rate and its conditions can be completely different — but more often, from 5% to 10% per annum. HELOC designed for 10-15 years of repayment, although longer-term loans are also possible. HELOC, like most credit cards, have variable interest rates that change over time along with various external factors:
  • markup or surcharge that based on your credit score
  • repayment history
HELOC interest rates are the same. However, HELOCs often have significantly lower interest rates than credit cards. That being said, when interest rates go up, people who thought they were borrowing money cheaply are already in HELOC. 

High interest debt refinancing 

Let's imagine that the HELOC interest rate is, for example, 5.5% and interest payments are taxable — while your credit card debt has an interest rate of perhaps 29.9% and interest payments are not taxable. In many cases, HELOC can save a ton of money and get out of debt faster by consolidating and using funds to pay off credit card balances. In effect, users change from a high-interest loan to a low-interest loan. However, some people will use HELOC to pay off high interest debt — and then use their newly topped up credit card limits to accumulate even more high interest debt. The name of this practice is 'rebooting' and rarely ends well. Remember that if you choose HELOC, you could theoretically lose your home.

HELOC repayment rules

  • HELOC is similar to a regular mortgage and is paid out in equal installments over a fixed period
  • there is a period (a year, three, five, ten — depending on which bank and what are the conditions) of minimum payments and payment of interest for use, then a period of payment of the entire amount. There are loans (balloon) when at the end of the 'life of the loan' it is necessary to pay the entire amount

Conclusion 

When choosing HELOC, you always need to know when and by how much your interest rate may change before taking out a loan. Can you afford the monthly payments if they are different?  You should also think about how you plan to use the money — this will help you decide if HELOC can help or hurt your finances in the long term. If you have a habit of abusing credit, you may be better off keeping your net worth intact and keeping your debt only on your credit cards. In any case, when making such a decision, first consult with a specialist to know all the pitfalls. It is he who will be able to 100% answer your question — is it worth taking HELOC in 2023. For any questions related to the purchase or refinancing of real estate — please contact us. We are ready to answer and sign you up for a consultation at +1 (818) 309-2999.