Home Equity Line Of Credit And How Does It Work
This BLOG On What Is A Home Equity Line Of Credit And How Does It Work Was UPDATED On April 19th, 2019
Homeowners with sufficient equity in their home may be able to qualify for a home equity line, also referred to as HELOC.
- Most homebuyers put very little money down on a home purchase
- Chances are very slim new home buyers will be able to get a home equity line of credit right after closing on their home loan
- HELOC stands for a Home Equity Line of Credit
- It is different than a home equity loan
- HELOC allows homeowners to use it and pay it off whenever they want like a revolving line of credit
- A home equity loan, the bank will give homeowners a lump of cash at once similar to an installment loan
A home equity loan works in a different way than a Home Equity Line in a sense that once you pay off the balance of the home equity loan and cannot reuse it like a line of credit.
Equity Required To Qualify For HELOC
Homeowners who owned a home for some time, check to see if home has appreciated in value.
- Many home values have increased significantly over the past few years
- Some counties in California, Florida, and Illinois have seen property values increase double digits
Qualifying For A HELOC
Banks will fund a home equity loan to a homeowner who has sufficient equity in their home.
- Home equity lenders will base their lending decision on the credit and financial profile of their borrower and the equity the borrower has on their home
- Home equity loans and home equity lines is known as second mortgages
- Second mortgages are when lender stands in a second lien position to the property behind the first mortgage lender
- By being on a second lien position, the lender stands to hold greater risk than the first mortgage lien holder
- In the event, if the homeowner defaults on the first mortgage, the second lien holder stands a greater risk of not getting paid on their collateral if there is not enough money to pay off the first lien holder
- The second mortgage lien holder can pay off the first mortgage lien holder and acquire the property
- But this is not often the case
- This because there is normally not enough funds from foreclosure even to pay off the first mortgage lien holder in full on cases of foreclosures
How Much Can You Borrow On Home Equity Line Of Credit
The maximum amount homeowners can borrow on a Home Equity Loan depends on how much equity they have in their home. Depends on the loan to value of the property.
- Every second mortgage lender have their own standards and guidelines
- Some second mortgage lenders may cap the debt to income ratios at 40%
- While others may cap it 45% DTI
- Second mortgage lenders will go to 85% to 90% loan to value
- There are second mortgage lenders who will lend up to 95% CLTV
Terms on a Home Equity Loan and HELOC is normally 10 years to 15 years. Many times, the second mortgage lender can offer interest-only payments on second mortgages.
Types Of Home Equity Line Of Credit
Home Equity Line of Credit is a second mortgage that is in a form of revolving credit. It works somewhat like a credit card.
- The lender will extend the maximum available credit based on borrowers credit and loan to value
- Borrowers can then use and pay down the Home Equity Line of Credit anytime
- After the specified period, the draw period has expired, the Home Equity Line of Credit can convert to a second mortgage term loan
- Repayment periods can vary from lender to lender
- But the range of the repayment period is usually 15 to 20 years on a HELOC
Second Mortgage Qualifying Factors
Three factors that come into play in qualifying for a home equity loan:
- Debt to income ratios
- Loan to value
Since second mortgage lenders carry greater risk. Lenders will want a strong credit borrower. Most home equity loan and HELOC lenders require a minimum of a 700 credit score. Debt to income ratios cannot normally exceed 45% DTI including the home equity loan payments. Loan to value will vary between 75% to 95% depending on the second mortgage lender.