If you're considering utilizing a Home Equity Line of Credit, commonly known as a HELOC, for a home renovation or other large purchase, you're not alone.
Nationwide, balances on HELOCs increased by $2 billion in the second quarter of 2022, according to data from the Federal Reserve Bank of New York. That's after U.S. homeowners had a record high of $8.1 trillion in available home equity at the end of the first quarter, and home owners put those funds to work after spending so much time at home during the pandemic. Home renovations funded through a HELOC are the most common use of home equity, but a HELOC can free up cash for a variety of uses.
But what is a HELOC and is it right for you? As you consider your next financial move, here are some things you should know:
1. What is a HELOC and how does it differ from a home equity loan?
A HELOC is a line of credit that you can tap into as you need it during a set duration of time,
known as a draw period. Draw periods usually range between five and 10 years. This process differs from a home equity loan, which you receive in one lump sum. For instance, let's say you are approved for a HELOC for the amount of $15,000. You then draw $5,000 of it to remodel your kitchen and then an additional $9,000 for a pool resurfacing. You still would have $1,000 available until you reach the credit limit, but you don't need to tap into that $1,000 if you don't want to. You would only pay interest on the portion that you borrowed. By contrast, if you are approved for a $15,000 home equity loan, you would receive all the proceeds, after closing costs, all at once. Then, you would repay the full loan over a set repayment period, which usually ranges from five to 30 years.
In both cases, you don't have to use the money for home improvement or other home-related costs. In BOK Financial® Home Loans Product Manager Kurt Morris' words: "As long as it's legal, you can use the money for any purpose—whatever you want or need. Home equity gives you a lot of options."
|
Home Equity Line of Credit (HELOC) |
Home Equity Loan |
|
|---|---|---|
|
Interest rates |
Adjustable but you only pay interest on the portion borrowed. |
Fixed but you pay interest on the full amount of the loan. |
|
When you receive the money |
You can tap into the line of credit as often as you need it, up to the credit limit, during a draw period. Draw periods usually range between five and 10 years. |
In one lump sum after the loan closes, which usually takes around four to six weeks. |
|
Closing fees |
Depends on the financial institution. |
Depends on the financial institution. |
|
Shows up on credit report |
Yes |
Yes |
2. How do these options differ from my mortgage?
Both HELOCs and home equity loans require separate payments than your usual mortgage payments. Your mortgage and either of these loan options also may have different interest rates, and generally your mortgage interest rate will be the lowest. However, if you do a cash-out refinance—that is, replacing your mortgage with a new, larger one—you first will pay off the original mortgage and then can use the remaining money however you like.
3. Would rising interest rates affect my HELOC?
Unlike home equity loans, which have a fixed interest rate, HELOCs are adjustable rate, which means that the amount of interest charged changes over time. The interest rate you pay on a HELOC is determined by two things: a benchmark set by your financial institution and your own personal financial situation. This benchmark tends to move up and down with the Federal funds rate, which is set by the Federal Reserve. This means that, even if your personal financial situation does not change, the interest rate on your HELOC might. At the same time, rising interest rates tend to make some options for tapping into your home equity more attractive than others. As Morris explained, "As mortgage rates increase, options like home equity loans and home equity lines of credit (HELOC) become more attractive because there are fewer fees than refinancing."
Depending on the financial institution, you may be able to convert portions of your adjustable-rate HELOC into fixed-rate loans to have stable payments and to reduce the impact of rising rates.
4. Would I have to pay any closing fees?
It depends on your financial institution, as some charge closing costs and other fees, while others do not. That said, there tends to be fewer up-front fees and costs associated with a HELOC than with a cash-out refinance (replacing your mortgage with a new, larger one). Home equity loans also tend to have lower closing costs than a home refinance, and some financial institutions will waive closing costs for them.
5. Would a HELOC show up on my credit report?
Yes, like loans and other lines of credit, a HELOC would show up on your credit report. If you're concerned about how a HELOC might affect your credit score, keep in mind that all three credit reporting agencies determine your score by factoring five criteria: your payment history (35% of score), the total amount of debt you owe (30% of score), the length of your credit history (15%), the types of credit you have (10%) and any new credit you have (10%). Having a line of credit that you make on-time payments to can sometimes even raise your score.
6. How long will it take to receive my money after a HELOC is approved?
A HELOC is usually the fastest way to get home equity-derived cash on hand. It usually only takes two to six weeks to close. By contrast, with a home equity loan or a cash-out refinance, it usually takes about four to six weeks to receive your money.
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