Last Updated on February 23, 2022 by Kravelv
With the growth of financial markets around the world, there are numerous ways of raising money. However, retail borrowers are always on the lookout for a cost-effective way. One of the prominent options is the home equity line of credit (HELOC).
Most people use HELOC for their day-to-day expenses as the interest rates are generally lower. Also, the prepayment penalties are non-existent, and you can borrow as much money you need against the available line of credit. If you have a significant amount of equity in the home, you may qualify for the home equity line of credit.
What Is A Home Equity Line Of Credit?
According to sccu.com, HELOC is a kind of secured form of credit that serves as a revolving source of funds and a low-cost alternative to other lines of credit. In this kind of credit, you can borrow the money, pay it back, borrow it again, and you can do it up to the maximum credit. The process is similar to the credit card but offers a low interest rate.
You can borrow the money against the equity in the home, and your home is used as collateral. Just as in the case of a credit card, when you repay the outstanding balance, your available credit is replenished again enabling you to raise a fresh loan.
When Should I Opt For HELOC?
If you owe heavy debts or require a sizable sum of money for heavy expenditures such as new capital purchases, you can consider applying for HELOC. It includes
- Home renovations
- Medical expenses
- High-interest credit card bills
- Child’s tuition
- Vehicle purchase
- Debt consolidation
- Investment opportunities, and many more.
HELOC is one of the beneficial ways to take care of your day-to-day expenses. It is a better decision than paying the high-interest bills associated with credit cards. Many homeowners consolidate their debts, reduce the total interest rate on their debts by taking advantage of the HELOC.
However, before you apply for HELOC, you need to keep a check on your financial situation. Sometimes, people use it to live a lavish life, but they end up having more debts than before. Hence, using the HELOC for purposes such as home renovations or your child’s education would be a better option. When you spend money on home renovations, you add value to your home and create equity in the home. This would provide you with enhanced financial opportunities in the future.
How To Qualify For The HELOC?
There are many key factors that a lender considers before providing a home equity line of credit. The terms and conditions for providing HELOC vary from lender to lender. In general, a lender will look at the following requirements to mitigate their risk.
Available Equity
Equity is the difference between your home’s current market value and outstanding mortgage & loan balance.
Equity= Home’s current market value – Outstanding mortgage
Generally, a home line of credit is offered to those borrowers who own at least 20% equity in the homeowner’s property. Also, in some cases, lenders might require you to own as much as 35% of your home’s equity depending on the location of your property. However, you would not be able to a sum equivalent to 100% of the available equity. Typically, you can access around 80% of the available credit.
For example, if the value of your home turns out to be $5,00,000, you would need to own equity worth $1,00,000 (20% of the value) to qualify for HELOC. Once you are eligible for the loan, you would be able to borrow up to $80,000 (80% of the available equity) as HELCO.
Credit History
It is another factor that decides whether your HELOC can be approved or not. Also, it plays a vital role in deciding your interest rates. A score of 700 or more is considered to be a good credit score. However, even with a score of 620 or higher, there are chances your loan might be approved. Make sure you pay all your dues on time and maintain a clean credit record to obtain a higher credit score.
Debt-To-Income Ratio
Debt-to-income (DTI) ratio helps the lender to mitigate the risk factors. Lenders often require a ratio of 43% or lower in the case of home equity loans. You can also calculate the DTI ratio before applying for the HELOC.
1. Add all the debts like current mortgage payments, credit card debt, car loans, student loans, and any other existing loans.
2. Add your gross monthly income such as salary, commissions, and bonuses. If you have other income sources like spouse salary or rental income, you must add them too.
3. Divide your total income with your debts, and you will get the DTI ratio.
Ability To Repay
Your lender always checks your financial background to mitigate the risk of non-payment. You would also be required to furnish previous mortgage documentation and your repayment history.
Lenders would also evaluate whether you have a sufficient stream of income or not. It helps them to identify whether you can pay the loan on time or not. You can furnish your past income tax returns or salary certificates from your employer as proof of income. In case you are self-employed, you might be required to furnish bank records and business books to establish the reliability of your income.
Endnote
A home equity line of credit is a cost-effective option to finance your expenses. Although the eligibility criteria are by and large the same, there might be some variation depending on the lender. Make sure you understand the requirements thoroughly before opting to take out a loan.
It is also a good idea to compare the terms and interest rates of various lenders. It might help you save money on initial direct costs as well as interest. However, one needs to observe financial discipline in order to pay back loans on time and make sure you plan your budgets accordingly.