How to get a home equity line of credit (HELOC)
Please note: Discover® Home Loans offers a home equity loan product, but does not offer HELOCs.
A home equity line of credit (HELOC) lets someone use the existing equity in their home as a revolving line of credit. HELOCs and other loans like home equity loans and cash-out refinances are great for getting quick funding for big projects. Cash pulled from a HELOC or a similar loan can then be used to finance all sorts of projects, including home improvements, upgrades, or renovations.
This article explores what a HELOC is, how the line of credit works, and some of the best alternatives to a HELOC.
Are getting a HELOC and getting a line of credit the same?
A line of credit is a source you can tap for funds at any time up to a pre-determined amount. This flexibility means you don’t have to borrow more than you need.
A HELOC works as a revolving line of credit, meaning anyone with a HELOC can take out cash as necessary. However, HELOCs work differently than other lines of credit.
A HELOC is a secured loan where the lender secures the loan against the borrower’s home. If someone defaults on a HELOC, they could be at risk of losing their home.
Many other lines of credit, like credit cards, work as unsecured loans. Opposite to a secured loan, borrowers aren’t at risk of losing assets in the event of a default.
How does getting a HELOC work?
To get a HELOC, you first need to have equity in your home. Because HELOCs use your home equity as a revolving line of credit, lenders will set a minimum amount of equity you must have in your home to qualify for the loan.
Lenders also set requirements beyond home equity to qualify for a HELOC, all of which you must meet to be eligible for the loan. These requirements can vary from lender to lender.
After getting a HELOC, you can tap into your home equity as needed to pull out cash. The benefit of using a revolving line of credit is that you don’t have to take out the full amount you’re qualified to borrow.
However, HELOCs usually come with variable interest rates where the loan starts with a set rate and at a set point during the loan term, the rate can change. This is bad news for anyone concerned about rising mortgage rates as a variable rate adjustment could lead to a higher HELOC interest rate.
Before jumping into a HELOC, it’s a good idea to check different lenders to shop rates and terms and compare HELOCs to similar products before committing to any loan.
Requirements for getting a home equity line of credit
All HELOC applications generally require a minimum credit score, loan-to-value (LTV) ratio, debt-to-income (DTI) ratio, and income level. While specific requirements can vary by lender, all lenders will check these four factors when evaluating applications.
Credit score requirements can vary significantly from one lender to another. However, the higher the credit score, the better the HELOC rate a lender will offer. So, while a lower score may qualify you for a HELOC, working on getting a higher score can save you money by potentially getting you a lower interest rate.
Loan-to-value, or LTV, shows how much equity is put toward the total cost of a loan. For example, a home with $100,000 in equity on a $400,000 mortgage would have an LTV of 25% ($100,000 divided by $400,000).
Similar to a mortgage requiring a down payment, a HELOC requires minimum equity in the home. Having more equity can mean friendlier loan terms.
Debt-to-income ratio, or DTI, represents how much of an individual’s income goes toward debt.
For example, someone earning $5,000 per month with $1,000 in debt obligations (including a mortgage payment) would have a DTI ratio of 20%, or the percentage of monthly income that goes to debt.
Homeowners can typically qualify for a HELOC with a DTI ratio as high as 43%, though lower DTI ratios might mean better HELOC rates.
To qualify for a HELOC, you need to submit proof of income. Your income helps the lender determine the DTI ratio. Required income levels vary based on total home equity, the home's value, the HELOC's size, and many other factors.
Alternatives to taking out a home equity line of credit
While HELOCs can be great for financing products, these mortgages are not best for everyone. Fortunately, many other types of loans that are similar to HELOCs are available — like home equity loans and cash-out refinances.
If you’re looking to access your home equity funds, here are some HELOC alternatives to consider:
Home equity loan
Like a HELOC, a home equity loan taps into your home equity to provide you with funds. But this loan is different from a HELOC because home equity loans come with set loan terms, including how much cash you pull from your home equity.
Home equity loans often come with fixed interest rates, keeping monthly payments consistent during the life of the loan. Fixed interest rates also protect people from rising interest rates over the loan term.
A cash-out refinance is a type of mortgage refinance that allows you to borrow cash for anything from a home renovation to a new boat.
With a cash-out refinance, you take out a loan for more than your current mortgage. You then pay off your mortgage with the loan and receive the remaining amount of the bigger loan in cash.
While a cash-out refinance doesn’t work the same as a HELOC, it can be an equally effective way to generate funds.
Credit cards can serve as a revolving line of credit like a HELOC. As unsecured loans, the risk of borrowing from a credit card is generally lower than using a HELOC. However, credit cards often come with much higher interest rates than HELOCs, meaning higher monthly payments for the same amount of money borrowed.
Another benefit of using a credit card over HELOC is getting the funds much faster. Anyone interested in using a credit card to finance a big purchase should consider opening a new card with a low-to-no introductory APR to save money.