Home Equity Line of Credit

House constructed of hundred dollar bills
One of the most versatile tools available to homeowners with property containing at least twenty percent equity, a home equity line of credit (HELOC) can help secure large sums of money for necessary purchases or for the consolidation of other forms of debt. Just as all other types of loans are associated with potential disadvantages and possible benefits, HELOCs should also be considered for their ability to assist or to hinder homeowners in financial need.

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An integral part of approving HELOC applications for lenders is investigating the amount of equity that a borrower’s property contains. Most lenders will only consider 75 percent of the home’s appraised value less the balance owed on the property. The figure derived from that formula gives borrowers an idea of how much they can receive from a home equity line of credit.

In addition to verifying borrowers’ equity and credit scores, lenders also concern themselves with the owners’ debt-to-income (DTI) ratio. The DTI ratio is determined by taking a homeowner’s gross monthly income and subtracting all bills from that total, then multiplying it by whatever percentage a lender feels comfortable with (usually 28 to 36 percent). So long as the borrower’s DTI ratio can adequately cover the monthly expense of the home equity line, the lender can consider the applicant.

Like a second mortgage loan, a HELOC is taken out against a borrower’s existing equity in their property. As a result, borrowers need to be careful with their home’s value since, if a borrower has a HELOC and their equity falls, a lender can sever that line of credit at any time. This was seen during the 2007 financial crisis, and many who turned to their HELOC for emergency money found their safety net cut off.

Another risk with HELOCs is that when the term limit expires, lenders usually require the entirety of the HELOC to be paid off in a single balloon payment. Consequently, borrowers can sometimes be surprised by the large amount of money they have access to one day, and the large amount of money they owe the following day.