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Understanding Home Equity Lines of Credit (HELOCs)

A home equity line of credit (HELOC) allows you to use the equity in your home as collateral for a revolving credit line. While HELOCs can be valuable financial tools, there are several common misconceptions about how they work. Let’s clarify these so you can make an informed decision about whether applying for a HELOC is right for you.

1. Myth: HELOC Approval Is Guaranteed

While the equity in your home secures the HELOC, approval is not guaranteed. Lenders consider more than just your home equity when reviewing your application.

Fact: Qualifying for a HELOC Depends on Multiple Factors

Lenders will evaluate various factors when reviewing your application and setting your credit line’s rates and terms. For HELOCs, lenders may require:

• Home equity: Lenders generally offer a HELOC with a credit limit that could bring your total mortgage balance to 60% to 85% of your home’s current value. This includes the HELOC’s credit limit plus your outstanding mortgage, meaning you need at least 15% to 40% equity in your home.
• Good credit score: A credit score of 680 to 720 is often required, although a higher score could improve your chances and offers.
• Verified income and low debt-to-income ratio: A stable income and a low debt-to-income ratio (DTI) are crucial. A DTI over 43% might make it difficult to qualify for a HELOC.

Requirements vary by lender, so it’s wise to shop around to find the best rates and terms.

2. Myth: You Need to Wait Years to Borrow a HELOC

Some lenders have waiting periods, but you don’t necessarily need to wait years to qualify for a HELOC.

Fact: There Is No Set Waiting Period for a HELOC

Even if a lender doesn’t have a waiting period, there are reasons most people don’t get a HELOC immediately. You might not have enough equity in your home yet, or it might make more sense to use a mortgage that provides cash for repairs or improvements.

If you’ve made a large down payment or your home is appraised for more than its purchase price, you might have enough equity to qualify for a HELOC from the start.

3. Myth: You Can’t Deduct Interest Payments on a HELOC

The Tax Cuts and Jobs Act (TCJA) of 2017 introduced changes to home equity interest, including the suspension of deductions for interest payments on home equity loans and HELOCs from 2018 to 2025. However, there are exceptions.

Fact: Interest Might Be Deductible Depending on How You Spend Loan Proceeds

You can still deduct the interest you pay on a HELOC if you use your primary or second home to secure the HELOC and use the money to buy, build, or substantially improve your home. For example, adding a new bedroom or upgrading your kitchen might qualify.

4. Myth: HELOCs and Home Equity Loans Are the Same

HELOCs and home equity loans (HELs) share some characteristics but are different in several important ways.

Fact: HELOCs and HELs Are Different Types of Loans

A HELOC is a revolving line of credit, similar to a credit card, that you can borrow against. You only pay interest if and when you take out a loan (called a draw) against your credit line. A home equity loan is an installment loan, similar to a mortgage or personal loan, where you receive the entire loan amount upfront and start making interest and principal payments immediately.

5. Myth: You Always Need a Full Home Appraisal

Your eligibility for a HELOC and your HELOC’s credit limit depend on your home’s current value and your outstanding mortgage balance. However, you don’t always need a full appraisal.

Fact: HELOCs Often Require an Appraisal, but Not Necessarily a Full One

Lenders generally require an appraisal before offering you a HELOC. Some may require a full appraisal, while others might accept a drive-by, desktop, or automated valuation appraisal, which can be quicker and less expensive.

6. Myth: You’ll Have to Pay Closing Costs out of Pocket

You might worry about the upfront cost of opening a HELOC, but you won’t necessarily have any out-of-pocket costs.

Fact: HELOCs Don’t Always Have Closing Costs

Some lenders cover the HELOC’s closing costs on the borrower’s behalf or split the costs. If you use a lender that doesn’t charge application or annual fees, you might not have to pay anything to open or maintain your HELOC.

7. Myth: Your HELOC’s Credit Limit Is Guaranteed

You might think you can rely on your HELOC’s credit limit as long as your account is open and in good standing, but that’s not always the case.

Fact: Lenders Can Freeze Your HELOC or Lower Its Credit Limit

Lenders can freeze your HELOC or reduce your credit limit if your home’s value significantly declines or if they believe you’ll have trouble making payments.

Should You Get a HELOC?

HELOCs offer a flexible funding option with relatively low interest rates. Using a HELOC for home improvements, debt consolidation, or other necessary expenses might make sense. However, HELOC amounts, rates, and credit limits aren’t guaranteed, and variable interest rates could become costly if rates increase.

Consider your options carefully. Start by estimating your equity based on your home’s current value and checking your credit report and FICO® Score. For any mortgage-related needs, call O1ne Mortgage at 213-732-3074. We’re here to help you make the best financial decisions for your future.

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