A home equity line of credit, or HELOC, is a second mortgage that allows you to borrow against some of your home equity. Home equity is how much of your home you really own, calculated by deducting the amount you owe on your mortgage from your home’s current worth. If you have at least 15% equity in your house, you may be eligible for a home equity line of credit.
A HELOC is a revolving, open line of credit. It works much like a credit card — you are able to use it as needed, repay the funds and then tap it again. However, a HELOC has some benefits over credit cards. One is that the amount you can borrow on your HELOC is likely to be higher than the balance limit on your credit card (think five figures instead of four). Another is that HELOCs currently have single-digit interest rates, compared to the 16 percent or more you’ll pay if you carry a balance on a credit card.
HELOCs generally have a variable interest rate and an initial draw period that can last as long as 10 years. During that time, you can make interest-only payments. Once the draw period ends, there’s a repayment period, during which interest and principal must be paid. You can no longer withdraw funds.
HELOC Calculator
Paying a loan back doesn’t have to be complicated or stressful. With the help of this home equity line of credit payment calculator, you’ll be able to create a personalized loan payoff and amortization schedule to stay on top of your finances. Recommended payments are based on your interest rate, loan amount, and the length of your loan term.
The amount you can borrow with a HELOC usually depends on how much home equity you have and your credit score. Typically, lenders won’t let you tap in to your home equity if you owe more than 85% of your home’s value. There are exceptions; some lenders will let you borrow against your home equity at higher loan-to-value ratios.
This calculator also assumes you have a conventional loan on a home that is your primary residence. Lenders generally require more equity for a HELOC that’s on a second home or investment property.
Calculating the monthly payment on a HELOC is tricky because the amount you owe each month can vary depending on several factors.
Your interest rate. Home equity lines of credit generally have adjustable rates, which increase or decrease based on prevailing interest rates. The rate you’re offered also depends on factors like your credit score, your equity and how much you’re borrowing. Some HELOCs have low introductory interest rates, so you may start out with especially low payments — it’s important to make sure your budget can handle larger payments down the road.
Age of the loan. If you’re within your loan’s draw period, you’ll be required to make payments only against the interest. This means your payments can be much lower than during the repayment period, when — as the name implies — you repay the principal and interest. Unless you make payments toward your principal during the draw period, your monthly payment will likely be substantially higher during the repayment period.
Rate caps. The adjustable rates on a home equity line of credit come with two key parameters. One is the lifetime cap, which is the highest interest rate you could possibly pay. The other is the periodic cap, which is how often the interest rate can change. Each of these can affect the amount of your monthly payments.
What are HELOCs Used For?
You can use the proceeds from your HELOC for anything. That’s a lot of financial freedom, so it’s useful to have some guidelines about how to spend the money. A few options, and whether they make sense:
- Home improvements and repairs: Yes. Using home equity to pay for kitchen renovations and bathroom updates is a no-brainer. These upgrades add to functionality and (generally) the resale value of your home. If you need a new air conditioner, for example, a HELOC is cheaper than carrying a credit card balance. However, be careful about using HELOCs to add a swimming pool or tennis court — these additions are expensive, and homeowners usually don’t recoup the full amount of the investment.
- Consolidating debt: Maybe. If you’re carrying credit card debt and paying double-digit interest rates, it could make sense to swap out expensive revolving debt for cheaper HELOC debt. This strategy comes with a big caveat, however: Pull cash out of your house to pay off the credit cards only if you’re not going to simply run up more debt. Otherwise, you’ll have the unfortunate combination of less home equity and an overhang of credit card balances.
- Investing: Probably not. Tapping home equity at 3 percent to fatten up your retirement savings made sense. However, using a home equity line of credit at 7.5 percent today probably isn’t ideal.
- Paying down student loans: Maybe. This one is a bit of a gray area. If you owe student loans from private lenders, it can make sense to pay those down by tapping home equity. In contrast to federal loans, private student loans carry higher rates and less flexibility. Federal loans have lower rates and more safeguards around financial hardships, so there’s no hurry to pay them down.
- Going on vacation or buying electronics: Hard no. Real estate is a long-lived asset that will give you years of use and almost certainly gain value. A Caribbean cruise or a gaming console, on the other hand, will be long forgotten even if you’re paying it off for decades. If a HELOC is your only option for paying for a vacation or another big-ticket item, better to put the purchase on hold.
Factors that affect your HELOC payments
- APR
HELOCs typically have variable rates, and the most relevant figure to you as a borrower is the APR, or annual percentage rate. It’s not uncommon for lenders to offer a low promotional rate for six months to a year. Your APR will then adjust to the market rate. After that, your HELOC rate will move up and down with interest rates.
- The age of the loan
HELOC repayment is unusual in that not only will your required payments change over time, but the method used to calculate those payments will also change. Typically, a HELOC has two distinct stages: a draw period and a repayment period. The draw period is the first stage, usually lasting between five and 10 years. During this period, your minimum monthly payments will be equal to the amount of interest that accrued that month. That means the interest rate of the HELOC and its current balance will determine the payment.
Read Also: Navigating HELOC Rates in 2024: What Homeowners Need to Know
As you draw more funds from the line of credit, the amount of the minimum payment will rise (even though it only covers accrued interest, that interest applies to a larger balance). Changes in the interest rate will also change your required payment. With most HELOCs, you can also opt to pay more than the minimum, to lower the outstanding balance during the draw period.
Once the draw period ends, you’ll enter the repayment period. During this phase, which can be as long as 20 years, you’ll have to make payments that cover interest and a portion of the loan’s principal. That means your payment will increase when the draw period ends and the repayment period begins.
- Rate Caps
Be sure to find out the maximum interest rate on your HELOC. HELOCs carry lifetime interest rate caps — so even if the prime rate rises and surpasses your rate cap, your HELOC rate by law can’t increase any further. If you have an existing HELOC, you can attempt to negotiate a lower rate with your lender. “Ask your current HELOC lender if they will fix the interest rate on your outstanding balance,” says Greg McBride, chief financial analyst at Bankrate. “Some lenders offer this, many do not. But it is worth asking the question.”
What is the Maximum HELOC Amount?
A home equity line of credit (HELOC) allows homeowners to borrow money against the equity in their homes.
The maximum HELOC amount you can borrow is determined by the value of your property, the amount owed on your current mortgage, and the percentage of the home’s value that your lender will allow you to cash out. Most lenders allow you to borrow up to 85%, but others will go higher—up to 90% or even 100%.
HELOC loan limits
Mortgage lenders determine the loan limit on a HELOC by offering a portion of your home’s value as your credit limit.
The maximum HELOC amount is shown as a percentage (usually 85%) which represents the amount you can borrow against your home in total — including your HELOC and anything you own on your existing home loan. This is known as your combined loan-to-value (CLTV).
Lender guidelines vary, but the average HELOC limit offered by most lenders is 80%-85%. That means your HELOC amount and your current mortgage balance, when combined, can’t exceed 80%-85% of the home’s appraised value. Some lenders allow up to 90%, and some even as high as 100%. The higher the LTV ratio, the higher your interest rate.
Typically, HELOCs that exceed 90% of the home’s value are only offered by lenders that issue memberships (i.e. credit unions).
Lenders can impose dollar limits on HELOCs as well as CLTV limits. Dollar limits vary by lender; $10,000 to $25,000 are “normal” lower limits often borrowed, while higher HELOC limits can range as high as $1,000,000.
How your maximum HELOC amount is determined
The maximum loan amount for a home equity line of credit varies by lender. The amount you can borrow also depends on:
- The amount of equity you have in your home
- Your credit scores
- Lender guidelines
If your house is worth $500,000 and you owe $350,000 on your existing mortgage, your loan-to-value ratio is 50% ($350,000 / $500,000 = .70 or 70%.) Many lenders offer HELOCs to a maximum of 85% loan-to-value.
Using the same scenario as above, here’s how a lender may determine how much you could borrow:
| Home Value | $500,000 |
| Current Mortgage Balance | $350,000 |
| Maximum LTV | 85% (0.85) |
| Maximum Total Balance (Mortgage + HELOC) | $425,000 ($500,000 x 0.85) |
| Maximum HELOC Amount (Total Balance – Mortgage) | $75,000 |
Factors that impact your max HELOC amount
Besides your home’s value, current mortgage balance, and lender guidelines, other factors may affect your maximum HELOC amount.
- Your credit score
The higher your credit score, the more likely you are to qualify for a low interest rate on your HELOC. A low rate helps increase your borrowing power. On the flip side, a poor credit score may hurt your chance of qualifying, or it could mean a higher interest rate and a lower loan amount if you do qualify. Most lenders require credit scores of 660 to 700 for a HELOC.
- The interest rate
Interest rates on HELOCs vary depending on your credit, your financial situation, and what the economy is doing at the time. Rates for second mortgages (HELOCs and home equity loans) are usually slightly higher than the rate you’d pay on a primary mortgage.
- Your debt-to-income ratio
Your debt-to-income ratio (DTI) will determine just how much you can afford to borrow when qualifying for a HELOC. Debts included in your DTI include your existing mortgage payment, credit card minimum payments, and payments on other installment loans like student or car loans. Child support and alimony payments are also included.
The less money you spend on other existing debts each month, the more you can borrow on a HELOC. The lender will require proof of employment and income in order to calculate your DTI. Typically, a HELOC requires a lower DTI than a traditional mortgage.
- New home appraisal
When you apply for a HELOC, your lender may require a new home appraisal. Your home’s appraised value is important because it’s used to calculate the amount of equity in your home. The higher your home’s appraised value, the easier it will be to borrow money based on your home equity.
What is Better Than a HELOC?
Home equity loans and home equity lines of credit (HELOCs) are both secured by the borrower’s home, but the payment schedules and interest rates differ. The optimal home equity program for you will be determined by your needs, goals, and spending patterns.
Because both use your property as collateral, they often offer significantly lower interest rates than personal loans, credit cards, and other forms of unsecured debt. However, users should exercise caution when utilizing either. Racking up credit card debt might cost you thousands of dollars in interest if you don’t pay it off, but failing to pay off your HELOC or home equity loan can lead to the loss of your home. Let’s look at how the two goods differ.
Home Equity Loan
A home equity loan is a fixed-term loan granted by a lender to a borrower based on the equity in their home. Borrowers apply for a set amount and, if approved, receive it in a lump sum upfront. The home equity loan has a fixed interest rate and a fixed payment schedule for the loan term. A home equity loan is also called a home equity installment loan or an equity loan.
The equity in your home serves as collateral, which is why it is called a second mortgage and works just like a conventional fixed-rate mortgage. You need to have enough equity in the home, which means that the first mortgage must be paid down enough to qualify the borrower for a home equity loan.
The loan amount is based on different factors like the combined loan-to-value (CLTV) ratio. You can usually borrow up to 85% of the property’s appraised value.
A home equity loan’s interest rate is fixed, meaning the rate doesn’t change over the years. Also, the payments are fixed, equal amounts over the life of the loan. A portion of each payment goes to the loan’s interest and principal.
Repayment generally ranges between five and 30 years, but the length of the term must be approved by the lender. Whatever the period, borrowers will have stable, predictable monthly payments to make for the life of the equity loan.
Home Equity Line of Credit (HELOC)
A home equity line of credit is a revolving credit line that allows the borrower to take out money against the credit line up to a preset limit, make payments, and then take out money again. A HELOC allows you to use it as needed as long as you make your payments. The credit line remains open until its term ends. Because the amount borrowed can change, the borrower’s minimum payments also change based on how it’s used.
‘In the short term, the rate on a [home equity] loan may be higher than a HELOC, but you are paying for the predictability of a fixed rate,” said Marguerita Cheng, certified financial planner and chief executive officer (CEO) of Blue Ocean Global Wealth
HELOCs are secured by the equity in your home. Unlike other types of revolving credit (think of credit cards, which are usually unsecured), you could lose your home if you default and stop making payments.
A HELOC has a variable interest rate, meaning the rate can increase or decrease over the years. As a result, the minimum payment can increase as rates rise. However, some lenders offer a fixed interest rate for HELOCs. The rate the lender offers depends on your creditworthiness and how much you’re borrowing.
During the HELOC’s draw period, you still have to make payments, which are typically interest-only. As a result, the payments during the draw period tend to be small. The payments become substantially higher throughout the repayment period because the principal amount borrowed is now included in the payment schedule along with the interest.
It’s important to note that the transition from interest-only payments to full, principal-and-interest payments can be quite a shock, and borrowers need to budget for those increased monthly payments.
There are many factors to consider if you need to take this step. Home equity loans provide the stability and predictability of fixed rates and payments while HELOCs come with variable rates. Be sure to also understand how you’ll use the money, what may happen with interest rates, your long-term plans, and your risk tolerance.
If you’re uncertain about how much you need to borrow and you’re comfortable with the variable interest rate, then a HELOC might be your best bet. As with any credit product, it’s important not to get overextended and borrow more than you can pay back because your home is the collateral for the loan.
