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What Is a HELOC and How Do They Work?

Posted by on May 2, 2019 in Stuff with 0 Comments

While it may take 30 years to pay off your entire mortgage, but the good news is that as you continue to make your payment each month it will put a dent in your balance.  As home values rise at the same time, equity is created and hopefully over time this continues to grow. There may be certain expenses that come up along the way where you don’t have savings built up, or doesn’t make sense to put on a high-interest credit card with no end to the balance in sight, that taking out a loan against your home makes sense.

It can sound negative to have a second mortgage against your home, but it’s a great way to have manageable payments while being able to complete your financial goals.  If you’re looking to pull equity out of your home, then a home equity line of credit (or HELOC) may be the best option for you. While sites like Home Equity Wiz provide plenty of additional detail on HELOCs, read on below for useful information that will aid your understanding.

How Equity is Calculated

Most lenders will cap the amount you can borrow against the home at 80%, which is really protection in case the home is defaulted on, the first and second lienholders would still recoup their loan balance with the sale of the home. To figure out the loan-to-value you would first take the amount owed, let’s say $120,000, and the appraised home value at $250,000. Dividing the two shows the loan-to-value to be 48%.  So, if you keep the 80% rule in mind, you could apply for an equity loan for 32%, or $80,000. This could be the maximum you could be approved for, although credit, income, and assets factor in as well as part of the approval process.

How Does this Differ from a 1st Mortgage?

A cash-out refinance is certainly an option for those looking to pull equity out of the home, but the amount of paperwork and fees associated can far outweigh the streamlined process of an equity line of credit.  With a traditional mortgage is for fixed terms, even home equity loans can be as well, which make a HELOC different in the fact that it works like a credit card where you are approved for a certain line amount and can borrow as you need funds. This way the balance you have to pay is only what you borrow, and not on the full amount, which is nice if you are not sure exactly how much you need. Interest rates also are variable, which can be a pro or con based on the current market, which differs from a first mortgage.

What Can the Funds Be Used For?

The short is answer is… anything you want. You have the flexibility of pulling out funds that can be used for a number of different ways such as completing a home improvement project like a bathroom or kitchen remodel, consolidating debt where you can combine multiple outstanding debts into one payment, or even pay for a wedding or vacation. Since it is a large line amount you can be approved for, even more than a credit card, it will take discipline so you don’t overextend yourself and be caught with climbing monthly payments

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