What is a HELOC?
HELOCs are secured loan products that provides borrowers with a line of credit. This means the borrower can get up to the value of the home equity as a line of credit. HELOCs are commonly used to consolidate debt because the interest rate on a HELOC is typically low. Lenders often will make up to 85% of a borrower's home equity available for a HELOC.
When getting a HELOC, it's important to consider the following:
- Credit scores and income. Since HELOCs are primarily a line of credit, the borrower's credit score is relevant in the HELOC approval. Lenders want borrowers to be trustworthy and have enough income to pay off the payments associated with the HELOC.
- Home equity value. The lender will only be willing to provide a line of credit that can be secured by the existing home value. Lenders will also want to make sure the LTV is manageable (eg. 85%) in order to ensure home price changes won't affect the underlying collateral.
- Market dynamics. Since there is volatility in the value of an investment property or home, market dynamics are important. If a property experiences devaluation, lenders can force borrowers to pay back a portion of the loan that is no longer secured by the lower equity. The major con of HELOCs is that, like the 2008 Financial Crisis, borrowers can be "underwater" and own negative equity in their home.