Have you ever wanted to buy another home, make an improvement to your current home, or get involved in an investment opportunity but not had the capital to invest? With home prices soaring the last several years, anyone who bought real estate in the last few years or earlier likely have a decent amount of equity in their home. But it is not easily accessed if you’re not willing to sell.
This is our personal journey: in early 2020, my husband and I were presented with an opportunity to invest in a house for a flip. The current owner didn’t have the capital to fix it up and sell it, so they asked if we would be investors/project managers. It was a fantastic opportunity we knew we couldn’t pass up, and we also knew we had equity in the home. By May 2020, we opened a HELOC on our home, used the account to make improvements on the investment home, and the investment home was sold in Nov 2022. We made roughly double our investment.
The HELOC enabled us to invest a large project that we wouldn’t have had the opportunity to do otherwise. Was it a risk, yes. Was it worth it, yes. This is a prime example of how a HELOC can be used. They often have introductory rates that are lower for the first six months, which make them perfect for a project or investment where the return is roughly 6 months. Accessing our home equity was a game changer in building our wealth, since we were able to use the proceeds to invest in future real estate ventures. Read below for more details about the HELOC process. Read the credit agreement VERY carefully. It should have all of this information for your specific HELOC. But hopefully this gives you an idea of what to look for and expect.
WHAT IS A HELOC?
HELOC stands for Home Equity Line of Credit. It is a credit account on the equity you have in your home. The amount of equity you may have access to = what your home is worth (appraised value) - what you owe on your home (mortgage balance).
A HELOC is not a mortgage or a loan, it is, just as the acronym implies, a line of credit. This is what sets it apart from a Home Equity Loan. A Home Equity Loan is given as a lump sum, has fixed monthly payments, and usually has higher closing costs associated. The HELOC provides flexibility to draw funds when needed, pay interest only on the amount you have used during the draw period (will be defined later), and usually has lower closing costs. Also with the a HELOC, you make interest only payments during the draw period. Our draw period was 10 years, just to give an example. Another difference is a HELOC is often variable rate and adjusted at the end of each month, whereas Home Equity Loans come in fixed or variable rate options. In either case, your home is used as collateral.
WHAT CAN YOU USE A HELOC FOR?
You can use it toward home improvements, flipping another house, buying another house, vacations, paying off higher interest debt, and more. All without having to sell your current home.
WHY A HELOC?
What is one of the biggest inconveniences about buying a new house? A few things come to mind, but one of the biggest is having to sell your current home to access the equity, before using that equity toward another down payment. All while you move out of your home, try to find a rental (and likely a storage unit), take however long it takes to find another home (or even build), and then move again… This is a huge inconvenience, inefficient, and involves a lot of variables. A HELOC is a great option if you want to access your home equity while still living in your home.
I would not recommend using a HELOC if the return is longer than a year or you don’t plan on selling or refinancing your house within the next year or so to pay the HELOC off. The largest reason why: these accounts are often variable interest rates that can climb as high as 18%, and adjust on a monthly basis. So, if you’re not committed to paying off the balance within a certain time window, be prepared to have an extra debt payment.
WHERE CAN YOU APPLY FOR A HELOC?
Mortgage companies, banks, and credit unions. We went through a credit union because that’s who we had our first mortgage with and they were offering a 1.99% interest for the first 6 months. You can usually start these applications online and the company will reach back out to you for more information to complete the application process. This is a personal bias: I don’t recommend using a bank for home related lending. I recommend a mortgage company, because they specialize in home lending, or a trusted credit union, because they offer personalized support and much better customer service.
WHAT DOES THE PROCESS LOOK LIKE?
1. Choose the lender. You can compare terms between a few different lenders based on the information they have online.
2. Apply. You can usually do this online just by providing a little bit of personal information, such as ID, estimates of household income/assets, approximate home value, and debt on home.
3. The lender will reach out to you for more information. They will likely ask for bank statements, pay stubs, and copies of your license(s).
4. The lender will run your credit and it will be a hard pull.
5. The lender will schedule an appraisal. You will be aware of when it is scheduled because the appraiser will likely need access to the inside of the home to make sure there isn’t significant damage or if you made upgrades.
6. Once the appraisal is received by the lender, final numbers will be calculated: how much you can/want to have as the limit on the HELOC, fees, interest rate, etc.
Example: Our home appraised for $190k, with $150 on the mortgage. This gave us the option to take a HELOC of $21k (90%) or $40k (100%). This is the breakdown of those two values: 1. 90% of the total appraised value is $171k (90% x $190k). Subtract the mortgage of $150k, and this gives $21k. 2. 100% of the appraised value is the total value, $190k. So, the difference between the appraised value and mortgage owed is $40k ($190k - $150k). Raising the HELOC to $40k, 100% of the appraised value, raised the interest rate after 6 months by 1%, to 5.25%. It comes down to risk and how much money you need/want access to.
7. After final numbers are established, the closing documents will need to be signed. The final signature did have to be in front of a notary, though.
Keep in mind, that title companies have a notary on staff during business hours that you can use. We didn’t have to make an appointment this. Closing at a title company is not needed, which saves some money. Fees and closing costs vary, but your lender should disclose these.
8. The signed papers have to be sent the lender. The lender will provide confirmation of receipt and then there is a three-day holding period. Saturday counts toward the three days, but Sunday does not.
9. The HELOC is approved!
This is usually about a 30-day process, start to finish. In our case, we had the option to have a specified amount transferred to our debit account upon approval of the HELOC, but you don’t have to use this feature. You can leave the HELOC balance at $0 upon approval, and draw as needed.
HOW DO I USE THE HELOC?
Once it’s approved, it’s like a line of credit. You can draw from it when needed. You have a specified limit, say $20k. So, you can draw any amount from the account up to that limit of $20k. If you’re approved for $20k, that is not delivered to you at closing and you make payments thereafter. No. Think more like a credit card, where you have a credit limit of $20k. It is essentially an open line of credit, with your home as collateral.
Some accounts require that you draw at least a certain amount within an initially time period after opening. We had to draw at least $5k in the first six months to keep the account open.
The account has its own card to use for purchases, and its own check book. There are no limits to where the card can be used or who you can pay via the check book. There may be daily draw limits associated, so read into those terms. Another option is to transfer the amount needed from the HELOC to your debit account directly.
Our total HELOC term was 25 years, with 10 years as the draw period and 15 years as the repayment period. You can only borrow from the HELOC during the draw period. Whatever amount you use from the HELOC during the draw period, you make interest only payments on. After the draw period, you make payments toward principal and interest on the final amount that was borrowed.
With an adjustable rate HELOC, the interest rate adjusts at the end of each month through the entire term (25 years in our example). In our case, the interest rate was 1.99% for the first 6 months, then 5.25% after. Interest only is the minimum payment due, but you can choose to make larger payments or pay the balance off. Paying off the balance does not automatically close the account and we didn’t incur any penalties for paying the balance off early.
The best thing about the HELOC is you can borrow from it many times over, as needed. Draw $15k to add a deck, pay it off in a year. Then in another year draw $20k for the down payment on another home. The options are endless.
WHAT HAPPENS WHEN I SELL THE HOME?
If you sell your home, the HELOC has to be paid off at closing and closed. As long as you own your home, you have access to this line of credit. If you use the value toward improving your home or another home that you owe, the interest can be written off during tax time. Check with your tax professional for more details.
WHAT IF YOU REFINANCE AFTER TAKING THE HELOC?
We did. And we still have the HELOC. When we refinanced, we combined the amount left on our mortgage with the amount that we had left on the HELOC. The new mortgage paid off both the original mortgage and the HELOC, and the HELOC remained open but paid off.
The HELOC does not automatically close after it’s paid off. We think of it like an open line of credit, a safety net in case we need to make a major home repair in a pinch or if other expensive life events occur.
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