Home equity lines of credit (HELOC): Requirements, Terms and Repayment
If so, you may be well-positioned to borrow against the value of your home to achieve other financial goals, such as:
- Making home improvements
- Consolidating debt with a lower rate and one monthly payment
- Paying for education expenses, major medical bills or other significant life events
- Refinancing your mortgage or an existing home equity loan or credit line
While Discover® Home Loans only offers home equity loans, some lenders provide home equity lines of credit, known as HELOCs. Here, we will explain the differences between a home equity loan and a HELOC, the typical terms within a HELOC, and the eligibility requirements borrowers typically should meet to earn HELOC approval.
Home equity loan vs. HELOC
Home equity financing typically comes in two forms:
- HELOC. A HELOC (pronounced "hee-lock") is a revolving line of credit that lets you withdraw funds, up to your approved credit line limit, during an initial term, called a HELOC draw period. While some HELOCs allow you to pay interest only during the draw period, when the draw period ends, the repayment period begins, where you cannot take out any additional funds and you will pay back the principal of the loan, along with interest charges. HELOCs typically feature variable interest rates (although some HELOCs use fixed rates). These are determined by adding a margin determined at origination to an index like the national prime rate (which can fluctuate up or down over the life of your loan). The margin is determined at origination and could depend on a variety of factors including the amount borrowed, the length of the repayment period, and the borrower’s credit score and income. A HELOC may be a good choice when you intend to borrow various sums from time to time rather than all at once.
- Home equity loan. A home equity loan gives you a lump sum, typically with a fixed repayment term of 10, 15, 20 or 30 years and fixed rate and payment. A home equity loan may be a good fit when you know how much you want to borrow and for how long, and when you prefer the stability of a fixed-rate loan over the potential changes of a variable-rate HELOC.
Both types of home equity loans may involve closing costs and other fees. Home equity loans offered by Discover Home Loans do not charge closing costs at closing and has no origination fees.
How a HELOC Works
A HELOC can be a more complex financial product. When you apply for one, there are some terms you should understand.
Here are the details:
• Variable rate
Some HELOCs may have a variable rate, which can fluctuate as market interest rates change. When your HELOC's rate changes, your payment will also change.
Variable-rate HELOCs usually have two rate caps. The periodic cap limits how much your rate can increase each time it's adjusted. The lifetime cap sets the maximum rate you'll be charged, even if market rates are higher.
You'll only be charged interest for the loan amount of your HELOC that you draw.
• HELOC draw period
Your draw period is a set time frame, usually 5, 7 or 10 years, during which you can borrow funds from your HELOC. You'll typically have to make a HELOC minimum payment during your draw period if you draw any funds. You may be allowed to make interest-only payments during this period. If you repay funds during your draw period, you typically will be able to draw those funds again.
• Home equity line of credit repayment period
Your home equity line of credit repayment period is a set time frame during which you'll have to repay the funds that you borrowed. Your repayment term's length depends on how your HELOC is structured. During this period, your monthly payment will include principal and interest.
Your repayment period starts when your draw period ends, unless your lender approves an extension or you refinance your existing HELOC into a replacement HELOC with a new draw period.
Paying back a HELOC may involve a balloon payment at the end of the draw or repayment period. The amount will be depend in part on how much you borrowed and repaid during your draw period.
You should plan ahead for your balloon payment, which may be significantly larger than your HELOC minimum payment during your draw and repayment periods.
Your home equity line of credit repayment period is a set time frame during which you'll have to repay the funds that you borrowed
• Conversion option.
During your repayment period you may have an option to convert your HELOC into a home equity loan with a fixed rate and fixed monthly payment that includes principal and interest. This option may make sense for you if you want a fixed payment while you're paying back a HELOC.
What You Need to Get a HELOC
To qualify for a HELOC, you'll have to meet your lender's guidelines for this type of financing.
While the details vary from lender to lender, examples of typical requirements include:
• At least 15% (or possibly 20%) equity in your home.
Your home equity is your home's current value minus any amounts you owe on your existing home loans.
Your equity percentage is your equity divided by your home's value.
Here's an example:
|Current home value||$500,000|
|Home equity ($500,000 - $350,000)||$150,000
|Equity percentage ($150,000 / $500,000)||30%|
When you apply for a HELOC, your home's current value will be determined by an appraisal. The value may not be the same as your purchase price or property tax assessed value.
• DTI of at least 43% (or possibly up to 50%).
Your debt-to-income ratio (DTI) is your monthly income divided by your monthly minimum payments for your mortgage, car loans, student loans, credit cards and other debt. Your mortgage payment includes your property tax, insurance, homeowner or condo association dues, and any other mortgage-related fees that you pay every month.
Here's an example:
|Monthly mortgage payment||$2,000|
|Monthly car payment||$250|
|Monthly minimum credit card payment||$100|
|Total monthly minimum payments
|DTI ($2,350 / $6,500)||36%|
Your monthly income may include your salary, hourly wages, side hustle or gig income, interest, dividends, rent, alimony or other income that you receive regularly.
If your DTI is too high for you to qualify for a HELOC, you can lower it by paying off some of your debt to lower your monthly minimum debt payments.