There’s a good chance that fulfilling your lifelong dream was a chief motivating factor behind buying your home. And while many of us didn’t always take into strong consideration some of the downsides that can arise out of homeownership (maintenance, repair and less than ideal mortgage rates being just a few), for the most part we’re satisfied. The advantages certainly outweigh the disadvantages. And building equity is one perfect example. But actually being able to access home equity? That’s a different story. And with more and more Utah residents accessing home equity through HELOC, you may be asking yourself if it’s the right option for you.
There’s no one good answer to the question. On the one hand, home equity lines of credit generally tend to have significantly lower costs than those associated with refinancing your mortgage. But eligibility for a HELOC rate can depend on anything from your current mortgage balance to the actual appraised value of your home. And eligibility is never guaranteed.
If you’ve ever wondered what both the advantages and disadvantages of accessing home equity through a HELOC are, you may be in for a surprise.
What Is A HELOC?
A home equity line of credit (HELOC) is a revolving source of financing available from a lender based on the value of your home. It’s somewhat similar in theory to a credit card, only it uses the physical amount of equity currently in your home as a source.
The actual amount of equity available may surprise you. According to a new report from CoreLogic, the first quarter of 2020 saw an increase of over $590 billion dollars of equity in the first quarter of 2020 compared to 2019. That’s a year over year increase of 6.5 percent. And for homeowners looking to access home equity quickly and affordably, a HELOC can be a convenient and low maintenance option.
The closing costs associated with other financing options, such as loan origination fees and title insurance, don’t tend to occur with HELOCs. There may be additional service charges, but they’re relatively minor in comparison with the hidden fees you’ll find in other refinancing loans.
But the chief benefit of a HELOC is its absolute flexibility. As opposed to a traditional lump sum refinance loan, a HELOC offers you the ability to borrow exactly how much you need exactly when you need it—all at an interest rate that’s much more realistic than the average APR of a home equity loan. Repayment options can vary from a lump sum paid at the conclusion of the terms of your loan to monthly charges of fixed or variable rates with the option of yearly refinancing. You may want to speak with a loan specialist at your bank to discuss which options would be best for you.
As of August 2020, the average interest rate of a HELOC in Utah is approximately 4.89 percent, compared to the 5.35 percent you’ll pay in interest on a standard 10 year home equity loan. Again, that’s just interest alone. That doesn’t take into consideration the APR, which can vary dramatically from lender to lender; sometimes by well over an additional one percent. An APR which is virtually nonexistent in a HELOC.
Am I Eligible For A HELOC?
Eligibility for a HELOC is contingent on both the actual property value of your home as well as your credit score. Most lenders will allow a maximum limit of 85 percent of your home’s appraised value to be taken out over the course of a HELOC loan, although the actual amount you can withdraw will vary depending on your institution. Your debt to income ratio will also play a decisive factor in your eligibility, with the vast majority of banks only considering homeowners with 80 percent or less.
The average minimum credit rating considered eligible for a HELOC by most Utah banks is typically around 720. But if you haven’t checked your credit score recently, you may be in for a shock. According to a recent report from Experian, the average FICO® score in the U.S. is only 703. Utah may be a little bit luckier with an average credit score of 716, but that’s still below the eligibility threshold for many lenders.
Many banks can be relatively flexible about credit scores and your HELOC eligibility if the combined loan to value ratio (CLTV) of your home is less than 80 percent. Your CLTV is calculated by taking the balance remaining in your mortgage plus the limit of the HELOC divided by the final appraised value of your home.
Keep in mind that just like other home equity financing, the final appraised value of your home can differ substantially from fair market value. Your house that’s estimated at the average value of $355,484 for a single family home in Utah may only turn out to be valued at $300,000 after appraisal. And if you have less than 20 percent of equity available in your home, the chances of being approved for a HELOC can be fairly slim.
Note: Due to economic uncertainty as a result of the coronavirus pandemic, many national banks (including JP Morgan Chase and Wells Fargo) are choosing to temporarily freeze new applications for HELOC loans altogether as of August 2020. Please contact your provider for further information.
Helpful Tips To Consider When Applying For a HELOC
- Calculate the equity that’s currently available in your home with a HELOC calculator. Some banks may consider less than 20 percent available in home equity when applying, but it may not ultimately be worth the interest you’ll pay if you only plan on accessing a minor amount.
- Make certain you review disclosure documentation carefully. You may wind up having to open a separate account for your HELOC with an additional percentage rate or borrow an initial amount minimum that’s more than you actually need.
- Be wary of non-traditional lenders who will often charge additional fees and rates if your credit score is less than perfect. You’ll often wind up paying more than you actually should both in the short term and in the long run.
HELOCs Or Cash Out Refinancing?
One financing alternative that’s gained a reasonable amount of attention in recent years is cash out refinancing. A cash out refinance loan replaces your existing mortgage with an entirely new loan at a higher monthly payment. The difference between the balance of your original mortgage and the new terms is then paid out to you, giving you immediate access to funds.
In theory, it’s an intriguing idea. After all, you’re simply refinancing your mortgage with the added benefit of accessing home equity instantly; and depending on your lender, decreased interest rates. But there’s a few conditions that you may want to keep in mind when entertaining the idea.
For one, cash out refinancing can sometimes result at a lower interest rate. But that rate is frequently based on the terms of your new loan, not your existing one. And that also includes the difference you’re paid out in.
More common with cash out refinancing is a much higher APR than even many other standard refinancing options. Closing costs aren’t arbitrarily applied, and you don’t get to pick and choose them. Fine print can make all the difference in the world. Unless you know exactly what you’re getting into with any refinance loan, you may find a 2.70 percent interest rate could almost double to 4 percent if you’re not looking carefully.
But the greatest risk in cash out refinancing is just as big of a challenge in a HELOC. In both cases, you’re using your home as collateral.
What Happens If I Can’t Pay Back My HELOC?
Much like a credit card, you’re still under obligation to make regular payments with a HELOC; even if you’re not borrowing money regularly. And it’s neither a bottomless resource nor your personal piggy bank. Your home’s value justifies your borrowing limit. And unlike a credit card, non-payment doesn’t just affect your credit score. It can result in foreclosure.
It’s more common for lenders to simply freeze access to your HELOC. But freezing your HELOC can sometimes happen even if you’ve only missed two payments. Typically, a lender will attempt to reach out to you to discuss repayment options, ranging from interest only payments per month to fixed rate refinancing options. Depending on your given situation and your prior mortgage history, they may even suggest forbearance as an option, allowing you to temporarily waive payments for a given time (typically anywhere from three months to an entire year, depending on your circumstances.)
But foreclosure is a very real option with non-payment of HELOC loans. And if your HELOC provider happens to be the same provider of your existing mortgage, the likelihood is even greater. They can easily force a short sale if you can’t find a reasonable repayment alternative.
Unfortunately, debt is unavoidable for many Utah residents in 2020. And there are times in which you may need to sell your home as quickly as you can rather than accrue more debt. At Gary Buys Houses, we’ve been helping Utah homeowners meet lender demands and avoid the risk of debt for a decade. We’ll purchase your house as is, at a price that’s fair—with no obligations or hidden costs. We can arrange an opportunity to repurchase your home from us should you find yourself in less stressful circumstances.
Is a HELOC loan right for you? That depends as much on your eligibility as your given circumstances. Much like purchasing a home, financing loans come with any number of options. Just make certain you choose the one that’s right for you.