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

Example of How a Home Equity Line of Credit Works

To better answer the question, what is a home equity line of credit, let's take a look at how a HELOC could work.

The example below illustrates how a HELOC can work in general; the mechanics of Freedom Mortgage's own HELOC are described above and differ in some respects. 

• You apply for a line of credit, and your lender determines you have $50,000 of equity available in your home that you can borrow against. The amount is based on the combined value of all your loans relative to what your home is worth.
• You're given a $50,000 line of credit you can access over a draw period. In this case, let's say your lender allows you to access the line of credit over 10 years.
• In this generic example, you only need to borrow $20,000 right now for home improvements, so you borrow that amount, leaving $30,000 of untapped credit you can access later if you need it. (Note: with Freedom Mortgage's HELOC, the full $50,000 would be disbursed to you at closing rather than left undrawn.)
• You make monthly payments based on the amount you borrowed. In this generic example, you'll usually only pay interest at first, and monthly payments can vary if your lender's HELOC has a variable rate; with Freedom Mortgage's HELOC, the rate on each draw is fixed at the time of that draw.
• You need to borrow another $5,000 to make some additional home upgrades. You borrow that amount, leaving $25,000 available to borrow if you need it. Your monthly payment now takes into account the extra $5,000.
• The draw period ends and the repayment period begins. Eventually your draw period ends and you start making payments on the principal.

As you can see, this provides a lot of flexibility for how you manage your money.

HELOC Requirements

There are certain requirements you must fulfill to be eligible for a loan. The specifics can vary by lender, but this is what you will need as a general rule:

• Equity in your home: Lenders won't give you loans, including a HELOC, that exceed a certain percentage of your home's market value. This percentage, which includes the outstanding balance of your primary mortgage plus any second mortgage, like a HELOC, is usually around 75% to 90% of what your home is worth, but may be higher or lower depending on the lender, your property state, and your credit profile.
• Good credit: Most lenders require you to have a good credit score, or at least fair credit. Freedom Mortgage requires a minimum credit score of 640 to obtain a HELOC. You can check your credit reports to see if there are any problems with your record that would impact your ability to borrow.
• Debt-to-income ratio: Lenders consider your debt relative to your income. That debt calculated would include your potential HELOC. The maximum debt-to-income ratio for mortgages and HELOCs varies by lender; Freedom Mortgage's maximum DTI for its HELOC is 50%.
• Proof of earnings and employment: You'll have to show evidence of your income and show that you're steadily employed. Lenders usually like two years of stable employment.
• Home insurance: Lenders want to make sure that your property is insured.

Since the requirements for a home equity line of credit vary by lender, it's best to speak with a mortgage professional about their specific requirements. A loan advisor at Freedom Mortgage can help you walk through your options.

HELOC Pros and Cons

If you are thinking about applying for a home equity line of credit, here are some advantages and disadvantages to consider.

HELOC Alternatives

In addition to HELOCs, you can also get cash from your home's equity with a cash out refinance or a home equity loan.

• Cash out refinances: A cash out refinance allows you to access your home’s equity while refinancing your current loan. You get a new loan with a new rate and terms, and you can use it to pay off your old loan and use what’s left for nearly anything.
• Home equity loans: A home equity loan is a second mortgage on your home that provides a lump sum you can borrow. Rates are often fixed, and you pay your loan back on a set schedule, providing predictability.

Home Equity Line of Credit FAQs

If you still need to know more about how a HELOC works or if a home equity line of credit is right for you, the answers to these frequently asked questions can help.

What Credit Score Do You Need for a HELOC?

Credit score requirements for a HELOC vary by lender. While Experian reports most borrowers need a minimum score of 680 to qualify for a HELOC, and ideally a score closer to 720, some lenders will accept lower scores. Freedom Mortgage requires a minimum credit score of 640.

Is Getting a HELOC a Good Idea?

Getting a HELOC can be a good idea if you have equity in your home and need access to funds you can draw from as needed. However, before you get a HELOC, be aware that borrowing against your home can put you at risk of foreclosure if you miss payments. With some lenders' HELOCs, you should also consider that rates can be variable and change over time; Freedom Mortgage's HELOC instead sets a fixed rate at the time of each draw.

Is HELOC Interest Tax-Deductible?

HELOC interest can be tax-deductible under certain circumstances. You may be able to deduct your interest if you use the funds you borrow to substantially improve the home securing the loan. However, you must itemize your deductions. Be sure to ask a tax professional before you itemize to confirm you are eligible and that it's the best way to lower your tax bill.

Let Freedom Mortgage Help You Use Your Equity

Freedom Mortgage can help you access home equity by walking through the benefits of using a HELOC or cash-out refinance depending on your needs. Get started online today.