Home Equity Line of Credit
Minimum and maximum rates can vary by lender, so ask how low and how high your interest rate can go before selecting a lender and applying for your loan.
Pros
Low closing costs and fees
Most lenders will cover most or all the closing costs of a HELOC if you keep the credit line open for at least 36 months. Shop around to ensure you are using a low-cost lender.
One single payment on all your debt
Consolidating multiple debts to one loan with one monthly payment can have a positive financial and psychological effect, allowing you to focus on saving and managing your budget to stay within your means.
Possibility of lower interest rates on your debt
Credit card interest rates can be 30% or more. For well-qualified borrowers, a home equity line of credit could significantly lower the amount of interest you pay on your debt.
Variable interest rate
If you are opening your line of credit in a higher interest rate environment, a variable rate could be a plus—if interest rates go down, so can the rate on your loan. A declining rate allows you to allocate more of your payments to the principal and can lower your payments overall.
Potentially lower payments
Paying off your non-mortgage debts with a HELOC can allow you to amortize your debt over longer periods, possibly lowering your overall monthly debt payments.
Up to 30-year amortization
Most HELOCs are offered over 10–20 years, but some financial institutions offer amortizations for as long as 30 years. The longer the payback period, the lower your payments.
These are typically structured with a 10-year initial draw period and 20-year payback. During the first 10 years you can access your line of credit, and some lenders will allow interest-only payments. (These are generally discouraged but could be used for temporary relief while you get your finances back on track.) Once the payback period begins, you can no longer make withdrawals and payments must include both principal and interest.
Flexibility
A HELOC is an open line of credit that can be borrowed from as needed; interest charges accrue only on the outstanding amount.
Improved credit score
Consolidating consumer debt with equity from your home zeroes out credit card balances, improving your credit utilization ratio (the amount you owe on credit cards vs. your available credit). Unused available credit represents responsible borrowing habits and can increase your credit score.
Cons
Home at risk
Borrowing equity from your home to pay off consumer or any other non-secured debt turns your home into the backstop for all your debt. Should you default on your HELOC payments, you could lose your home.
Reduced home equity
Borrowing from your equity reduces your ownership share, which could hinder your ability to sell your home if real estate values decline.
Possibly higher interest rates
Because most HELOC interest rates are variable, if market rates rise, the interest rate on your loan could go up, leading to higher payments.
Potential for more debt
Paying off consumer debt with your home equity frees up credit on the paid off accounts. To reduce this risk, build a budget first and make sure you are resolved to not make any new purchases on credit until your HELOC is completely paid off.
Qualifying for a home equity line of credit
Loan-to-value ratio
A loan-to-value ratio on your home of under 80% is normally needed.
Credit scores
A FICO score of 740 or higher may qualify you for the best terms with most lenders. Borrowers with lowers credit scores may also qualify, but usually at higher interest rates, depending on the lender. Loan eligibility and terms vary by lender.
Debt-to-income ratio
A debt-to-income (DTI) ratio of less than 40% is generally required. Some lenders will approve loans up to 50% DTI.
Shopping for a home equity line of credit
Loan terms such as interest rates, length of loan repayment, fees, and processing speed can vary widely by lender. It can pay to shop around.
A good place to start can be your local credit union or bank. Getting several quotes and using comparison tools such as Forbes or Bankrate.com is a good way to begin your search for the best lender to meet your needs.