Digging out pay stubs. Looking up your credit score. Filling out applications. Doesn’t sound particularly fun, does it?
But a little effort can help you access the cash you need to achieve your personal and financial goals by tapping into what’s likely your biggest asset — your house.
A home equity line of credit, or HELOC, is a type of second mortgage that lets you borrow against your home’s equity through a revolving line of credit. With relatively low-interest rates compared to other forms of financing and flexibility in how you borrow money and repay it, a HELOC is a great choice for those who want to use their home equity to fund home renovations or consolidate debt.
And, with a hot housing market driving up home prices, many homeowners are finding themselves with increased equity to take advantage of. “Everyone should make their equity work for them, whatever that means to them,” says Tabitha Mazzara, director of operations at MBANC, a mortgage lending company headquartered in California.
If you need financing for an upcoming expense and want to use your home equity to secure it, here’s what you need to know about applying for a HELOC.
How to Apply for a HELOC in 4 Easy Steps
So you want to take advantage of the equity in your home. Now what? Experts say there are a few steps you should take to apply for a HELOC.
1. Decide if a HELOC is right for you
There are many ways to access the equity in your home, so start by looking at your financial situation and deciding if you have the means to take out a home equity line of credit.
“The first thing that [borrowers] need to look at is their ability to qualify,” Mazzara says. Even if you like the idea of a HELOC, make sure you’re a good candidate before you apply. HELOCs are best for people who have great credit scores and a stable income that’s easy to document, Mazzara says.
She also says it’s easier to qualify for a HELOC if you’re borrowing less than $200,000, and if you have plenty of extra equity in your home as a cushion that you’re not borrowing against.
One factor lenders will look at when evaluating your application is your combined loan-to-value ratio (CLTV): the total debt secured by your house (including your primary mortgage and any HELOCs or home equity loans) divided by your appraised home value. Different lenders have different requirements on the maximum CLTV they’ll allow, but in general, the lower your CLTV and the more equity you’re keeping in your house, the better your approval odds will be.
2. Contact a lender
If you feel that you’re a good candidate for a HELOC, the next step is reaching out to a lender. Mazzara recommends starting with the institution where you do your everyday banking. “Always start with your local bank,” she says.
Most banks offer home equity lines of credit, so it’s likely that your current bank or credit union can help you. That said, you can also feel free to shop around if you’re looking for a specific product or loan terms that your existing bank doesn’t offer.
As with any loan, experts recommend getting rate quotes from multiple lenders to find the best deal. When comparing rates from different lenders, be sure to factor in any annual fees, closing costs, and rate discounts for automatic payments as well.
For each lender, you can get the process started by walking into a local branch or reaching out online. “It’s really an individual choice. Everything can really be done online now,” Mazzara says.
Your lender can help you understand your options, or help you get into financial shape if you need to improve your credit score before applying. “I do a lot of educating our customers,” says Amy Vaughan, vice president, business development officer and Northeast Reading branch manager at Tompkins VIST Bank.
3. Submit your application
Once you’ve talked to a lender that you feel comfortable working with, you can submit a formal application for a HELOC.
The application is much like the one you submitted when you first took out your mortgage. It will require documentation to prove your income, your home value, your assets, and your credit score.
Depending on how much you’re looking to borrow and your combined loan-to-value ratio, the application could be lighter on documentation. For example, if you have plenty of equity in your home and you’re not looking to borrow all of it, the bank might let you skip a home appraisal, which can make the application and closing process quicker and easier.
4. Close on the loan
There isn’t much else for you to do once you submit your application. The lender will evaluate your documents and, if all goes well, offer you the HELOC. From there, it can take between 30 and 60 days to close on the loan and get your money.
Mazzara says most HELOC closings are mail-away, which means you wouldn’t have to attend in person.
Requirements to Apply for a (HELOC)
The application for a HELOC, much like a mortgage, requires certain qualifications for the borrower and specific documentation to prove it. Here are the requirements for the borrower:
- A good credit score. Mazzara and Vaughan say that a favorable credit score is usually in the 700s, and the higher the better. Your credit score will not only affect your interest rate, but also whether the lender will give you a HELOC at all.
- A reliable income. Lenders want to make sure that you’ll be able to keep up with the monthly payments of a HELOC, so they will require that you have a solid income that’s well-documented.
- An acceptable debt-to-income (DTI) ratio. This requirement will vary by lender, but they’ll usually want to see a low debt-to-income ratio — which means that your monthly debt payments are only a small fraction of your total monthly income. Different lenders may have different qualifying DTI ratios, but a good DTI ratio to aim for is below 43% to 50%.
- Sufficient home equity. Lenders want to make sure you have enough equity in your home before letting your borrow against it. Though requirements vary by lender, most lenders will allow a maximum combined loan-to-value ratio of 85% — meaning you need to keep at least 15% equity in your home after accounting for your HELOC, primary mortgage, and any other home equity loans or HELOCs secured by your house.
And here are the documents that lenders will require during the application process:
- Pay stubs. You’ll need these to prove that you have a reliable monthly income that can support the payments on your HELOC. Lenders usually ask for two recent pay stubs.
- Bank statements. Unless you already have your accounts at the bank you’re using for a HELOC, a lender will want to see statements that show your savings and assets.
- Proof of homeownership and insurance. Your lender will want to ensure you are the owner of the home you’re trying to borrow against.
- Mortgage statement. Vaughan says that lenders will ask for this to make sure you’re up-to-date on mortgage payments and taxes.
What Can I Use My HELOC For?
“[A HELOC] could be used for certain personal financial obligations, such as children’s college or private school, home improvements, [or] making some investments if you feel you want your money to make you a little money,” Mazzara says.
In other words, it’s a personal choice, but here are some of the most popular options:
- Home improvements: This is a classic use of HELOC funds because you’re leveraging the equity in your home to increase the value of your home. This can look like a kitchen remodel or a new roof, but experts say renovations are typically a safe way to use a HELOC because it’s likely to pay off down the line when you sell the home. In addition, the interest on a home equity loan or HELOC can be tax-deductible if you use it to make substantial improvements to a qualified residence and meet certain other requirements.
- Debt consolidation: Many borrowers choose to use HELOCs to pay off credit cards, personal loans, or student loans. This can be a good choice because HELOCs often have lower interest rates than other forms of debt, meaning you can consolidate to one monthly payment and pay less in interest over time. However, be sure you understand the risks of turning unsecured debt like unsecured personal loans, credit cards, and student loans into secured debt like a HELOC: if you default on your HELOC, you could lose your house. In addition, using a HELOC to consolidate your federal student loans will cause you to lose all federal loan benefits, so experts recommend thinking carefully before you do so.
- Education expenses/college tuition: If you’re stretching to pay for college expenses for a child or yourself, you could use money from a HELOC. This is generally not recommended unless you’ve maxed out your other options, like federal student loans or financial aid.
- Unexpected costs: Sometimes, borrowers pursue a HELOC simply because they need extra money to get them through a rough patch. Personal finance experts usually advise against this, and suggest building up an emergency fund in a savings account instead. But, some borrowers like using a HELOC as a cushion just in case. “It gives them peace of mind having available funds,” Vaughan says.
- Medical expenses: Many Americans face high medical bills after major procedures or hospital stays, even with insurance. One way to pay this off is with a HELOC. It’s an effective way to settle up with a medical provider while creating a manageable monthly payment for yourself. Before you do this, however, check with your medical provider directly to see if they offer any payment plans with better terms or lower interest rates.
- Investments: Some borrowers choose to leverage their home equity for further investments, whether that be in the stock market or in the form of rental real estate. Mazzara cautions that this is definitely a risky move — especially because an investment might tank and put your home at risk.
Is It Hard to Get Approved for a HELOC?
For borrowers who meet the financial requirements, getting approved for a HELOC can be quite easy and fast, experts say.
“[A HELOC is] the right choice for a person who has a very strong financial and credit profile and has the right loan-to-value ratio,” Mazzara says. In those cases, the documentation required is usually lighter, and they can be approved in as little as 30 days, according to Mazzara.
Vaughan agrees: “As long as [the borrower has] good income, they have the ability to repay, and their debt-to-income [ratio] is within [the lender’s] guidelines, approval is more likely,” she says.
HELOCs are best for borrowers with a really strong financial profile. If that’s not you, consider other lending options.
If your financial profile isn’t quite as strong, it might be harder to get approved. Before you apply for a HELOC, you should be realistic about your current financial profile and how that’ll affect your application.
For example: If you’re looking to exceed a 50% loan-to-value ratio, borrow more than $200,000, and your credit isn’t perfect? “I would say don’t even bother; it would be a fruitless endeavor,” Mazzara says.
Home Equity Line of Credit (HELOC) vs. Cash-Out Refinance
So maybe a HELOC isn’t right for you, or you just want to understand your options. One other way to tap into your home equity is with a cash-out refinance. A cash-out refinance allows you to access cash value from your home equity (just like a HELOC does), but involves taking out a new mortgage and using it to pay off your old one. Your new mortgage would be larger, therefore reducing your equity in your home but letting you pocket the difference as cash.
Here are the main differences between the two:
|Doesn’t affect your primary mortgage, instead adding another loan on top of it.||Involves refinancing your original mortgage into a new, larger mortgage.|
|You can continuously withdraw money up to the credit limit, similar to spending on a credit card.||The money comes out in one lump sum.|
|The interest rates, and therefore payments, are often variable.||The interest rates are usually fixed, meaning a stable monthly payment.|
|Often involve little or no closing costs.||Can involve more significant closing costs.|
|Can allow for interest-only payments during the draw period.||Does not allow for interest-only payments.|
|Pay interest on only the amount used.||Pay interest on the entire new mortgage balance.|
|Possible early closure fee if you pay off and close your HELOC before a certain amount of time has passed.||Possible mortgage prepayment penalties if you pay off your mortgage early (i.e. you sell your house or refinance later)|
Deciding between these options has a lot to do with your personal situation and the current interest rate environment.
HELOCs are usually better suited to people who want shorter-term financing, such as a renovation you plan to pay off quickly. They’re also great if you don’t need or want all of the money at once. Cash-out refinancing is better if you need a lump sum of cash upfront (maybe for consolidating other debts) and want a longer, 30-year payoff timeline.
You should also consider that interest rates are currently rising, and are expected to continue going up. This matters because HELOCs often have variable interest rates, and when interest rates go up, so will your monthly payments. A cash-out refinance, however, is usually a fixed rate, which would give you a predictable monthly payment for a longer period of time.
However, because mortgage rates have risen rapidly over the past year, those who already refinanced during the historically-low mortgage rate environment of the pandemic might not be willing to refinance again at a higher interest rate just to access their home equity. In that case, a second mortgage like a HELOC or a home equity loan can be the better option.