What to expect when applying for a HELOC

A home equity line of credit (HELOC) is a way to get a revolving line of credit against the equity in your home. Equity refers to the difference between the appraised value of your home and what you currently owe on it. A HELOC works very similarly to how a credit card works, where you can use as little, or as much, as you like and pay monthly installments on the balance.

When you're applying for a HELOC, what to expect with the process is something you should understand.

How does a HELOC work?

A home equity line of credit is very much like a credit card in that you can borrow money against your limit as often as needed until your balance reaches the credit limit. Typically, a HELOC has a variable interest rate based on the baseline interest rate. As the baseline interest rate fluctuates, the rate on your HELOC will also fluctuate accordingly. Your rate will be the index rate plus an adjustment based on your credit history.

HELOC vs. cash-out refinance

A cash-out mortgage pays off the balance on your existing home mortgage. You then take out a new mortgage that includes a cash-out amount of up to 80% of your home's value. You can use this cash-out on anything you like, such as home renovations.

This new mortgage is subject to fees such as closing costs, and it gives you the cash-out amount in one lump sum. A HELOC doesn't typically incur closing costs and lets you withdraw money as needed during your draw period.

Qualifying and applying for a HELOC

Requirements vary from lender to lender, but the general conditions are as follows:

• A debt-to-income ratio under 40%
• At least 10% equity in the value of your home
• A minimum credit score of 620

Applying for a HELOC is very similar to applying for a regular mortgage. You will need to have acceptable credit history and documentation related to income and other aspects of your financial situation. The steps are as follows: 

1. Use an online HELOC calculator or speak to your lender to determine if you have enough equity in your home.
2. Once you have a basic understanding of what you may borrow, start exploring your HELOC lender options.
3. Gather all the required documentation that you may need.
4. When you have found a lender you are happy with and have all the documentation, it is time to apply for the HELOC.
5. After you have applied and received approval, you will receive disclosure documentation. Make sure you understand everything in these documents and ask questions as needed. Also, verify that the HELOC will cover your needs and ask about different rate options.
6. The next step is the underwriting process which can be as quick as the same day to several weeks. You may need your home appraised to verify its value. 
7. Finally, you will have the closing where you'll sign the paperwork. At this point, you can use the HELOC.

Documentation needed for a HELOC application includes pay stubs, tax returns, W-2s, tax bills, a homeowner insurance policy, credit report, recent appraisal of the home, and current loan information. If you're self-employed, you'll need tax and bank statements to prove your income and that it's stable.

Borrowing limit with a HELOC

The maximum amount you can borrow will follow from the maximum percentage of the value of your home that the lender will allow. The HELOC plus the current mortgage must be below their determined portion of the appraised value, typically around 80%. 

As an example, let's say you own a $250,000 home with a mortgage that has a remaining balance of $150,000. The lender will allow up to 80% of the home's value overall that you can borrow against it. In this case, take 80% of $250,000, and you get a value of a $200,000 maximum total you can borrow against your home. Since your mortgage has a balance of $150,000, you would subtract the two figures and get the maximum HELOC limit of $50,000.

Paying back a HELOC

A HELOC involves two stages, the draw period and the repayment period. The draw period is the time frame in which you can borrow against your line of credit via transfer or a check. The draw period is also variable but is usually seven years.

Once you have entered the repayment period, you can no longer borrow against the credit line, and you must pay off the remaining interest and principal. Most of the time, the repayment period is 15 years.

Another aspect you should consider is that some lenders have a balloon payment at the end of the loan, which would be a large lump sum due at the end of the loan. To avoid this extra payment, make sure you can pay it all off during the repayment period or refinance your HELOC.

Should you get a HELOC?

It depends. You have to examine your goals and your current financial situation and decide whether the HELOC fits. Typical usage for a HELOC includes renovations, repairs or additions to your home, which could increase the value of your home. Another upside to a HELOC is that the interest  may be tax-deductible if used to improve your home. Please consult your tax advisor regarding interest deductibility as tax rules may have changed.

Other uses for a HELOC include education and vacations.

Get the best HELOC rate

Getting the best rate possible for your HELOC is entirely up to you. Do the research, find who offers the best rates, and get several quotes to verify. An excellent place to start is your current bank, credit union or mortgage lender.

Unlock the value in your home

An Alliant HELOC could help you get the funds you need when you need it. Pay for a home renovation, vacation home and more.

Want to learn more about HELOCs? Check out these other articles:

• How does a HELOC work?
• Paying for a big expense: personal loan, HELOC, or card