A comprehensive guide on HELOCs with Expert Tips on how to manage HELOCs effectively for major expenses, like home improvements.

Tapping into your home’s equity is a common way for homeowners to finance major expenses, such as medical bills, college tuition, or a home renovation project. However, this option mostly works if you have some home equity (which we’ll discuss later on). If you don’t have enough home equity, there’s no need to worry - you simply need a HELOC based on the after-renovation value (Like a RenoFi HELOC).

If you’re considering a HELOC for home renovations and wondering if it’s the right move for you, keep reading for answers to all your questions — from what a HELOC is, how it works, to whether a HELOC requires appraisals, credit checks, and everything else you need to know. Before diving into the details, let’s explore the basics of a HELOC and how it works.

What is a HELOC?

Definition of a HELOC: A HELOC stands for “home equity line of credit.” It is a financial tool that allows homeowners to leverage the equity they have built in their homes via a revolving line of credit, similar to a credit card. The HELOC is unique because it allows borrowers to access funds as needed, making it an ideal tool to leverage as a home renovation loan.

One crucial point to note about a HELOC is that it is actually a second mortgage. In other words, while it sits behind your primary mortgage, it is still a separate loan — a major benefit for homeowners who have locked in a great rate on their current mortgage. This is one significant difference between a HELOC and a Cash-Out Refinance, which would require you to refinance your first mortgage at a higher rate.

How Does a HELOC Work?

Unlike traditional loans that provide a lump sum upfront, a HELOC allows borrowers to draw funds from a predetermined credit limit. The HELOC is designed to have one period for withdrawing funds and another for repayment.

The HELOC Draw Period

The draw period allows homeowners to withdraw funds during a specified timeframe (usually 10 years) without making payments toward the principal - during this time the borrower only pays interest on funds withdrawn. Funds can be accessed in a number of ways with a HELOC, such as a check, credit card, or online transfer. If at any point during the draw process, you need more money to cover expenses, you can use one of these options to access the money quickly. 

HELOC Expert Tip: Although you don’t have to pay the principal during the draw period you must still make payments toward interest charged on the principal. You must pay the interest during the draw period. Also, if you are able to make payments during the draw period it is recommended that you do so. **If you are not able to pay the principal you will not be negatively affected until the draw period ends, unlike a Home Equity Loan.**

The HELOC Repayment Period

Next, the repayment period follows the draw period, during which borrowers must start repaying the borrowed amount (usually over 10 - 20 years). HELOCs often have variable interest rates, but some lenders offer the option of a fixed interest rate. A variable interest rate is an interest rate that can change over time based on fluctuations in the market. Unlike a fixed interest rate, which remains the same throughout the loan term, a variable interest rate can go up or down. 

HELOC Expert Tip: Utilize personalized HELOC calculators during the draw or repayment phase to gain valuable insights into your borrowing costs and repayment strategy. These calculators can help you estimate your monthly payments, assess the impact of interest rate changes, and determine the optimal repayment plan based on your financial goals. By leveraging these tools, you can make informed decisions, stay on top of your financial obligations, and effectively manage your HELOC throughout its term.

What You Should Know About HELOC Rates

HELOC interest rates play a crucial role in determining the cost of borrowing for homeowners. These rates are typically variable and can fluctuate based on market conditions. It’s important to carefully consider the interest rate offered by lenders and understand how it can impact your monthly payments and overall borrowing costs. 

Comparing rates from different lenders and exploring options for fixed-rate HELOCs can help you make an informed decision and potentially save money over the life of your loan. Keeping a close eye on interest rate trends and consulting with financial experts can also help you navigate the complexities of HELOC rates and secure the most favorable home equity line of credit. According to Bankrate, As of July 2023, the current average HELOC interest rate is 8.65 percent.

How to Get a HELOC 

Step 1. Finding a Lender

The first step in getting a HELOC is finding a lender. You’ll want to consider the rates you might qualify for, how much you can borrow, and your minimum credit score and income to see which banks are eligible candidates for your specific situation. 

Step 2. Apply For A HELOC

When applying for a HELOC, you’ll be required to provide similar documentation to a mortgage, i.e., personal contact info, proof of income and assets, and a list of monthly debt payments, as well as a possible credit check. Depending on the lender, there may also be an application fee, title search, and attorney’s fees involved.  To apply for a HELOC, you’ll generally take these steps.

• Research and comparison: Before you start piecing together how to get a HELOC, it’s best to research different lenders. You don’t want to only look at one lender—doing so could cost you more than you need to spend. Compare interest rates, fees, repayment terms, and any additional benefits or features to see who can offer you the best loan for the best price.
• Application: Once you’ve selected a lender, you will need to complete an application form. You may be able to apply online, over the phone, or in person, depending on the lender’s preferences.
• Documentation: Prepare the necessary documentation, which may include proof of income, bank statements, tax returns, and information about the property. The lender will specify the exact documents required.
• Property appraisal: Does a HELOC require an appraisal? In some cases, the lender may require a property appraisal to determine the current market value and confirm the available equity.
• Approval and terms: After reviewing your application and documents, the lender will assess your eligibility and determine the terms of the HELOC, such as the credit limit, interest rate, and draw and repayment periods.
• Closing and disbursement: If approved, you will proceed to the closing stage, where you will review and sign the loan agreement. Once the lender funds the loan, you can access the funds as outlined in the terms of the HELOC.

HELOC Expert Tip: When submitting your HELOC application, double-check all the required documentation to ensure accuracy and completeness. This will help avoid delays in the application process and increase your chances of successful approval.

Step 3. Prepare for The Approval Process  

After applying, the lender will then begin underwriting, which is where they check all the information you provided to approve you for the loan. They may ask you for additional information or documentation during this time or schedule an appraisal if needed. After underwriting, you’ll close on the credit line by meeting with a closing attorney to sign any required paperwork, similar to closing on the purchase mortgage.

HELOC Expert Tip: During the HELOC underwriting process, be responsive and provide any requested information or documentation promptly. This will help streamline the approval process and ensure a smoother experience when obtaining your HELOC.

HELOC Requirements For Qualification

To take advantage of a HELOC it’s essential to understand the eligibility criteria and the steps involved in the application process in order to qualify. For traditional HELOCs, qualification will first require you to have available equity in your home. In most cases, you can borrow up to 85% of the value of your home minus the amount you owe. A lender will also consider your credit score and history, employment history, monthly income, and monthly debts, just as when you first got your mortgage.

HELOC Expert Tip: If you’re considering a HELOC for home renovation purposes, a RenoFi HELOC is the best way to get the most borrowing power possible. That’s because these loans are based on the after-renovation value of your home, not the current value. You may be eligible for funding if you meet the criteria above.

HELOC Eligibility Criteria

To qualify for a HELOC, lenders typically consider factors such as credit score, income, and equity requirements. One of the biggest eligibility factors is home equity, and not having built up enough is a roadblock for many in need of a renovation loan. Luckily, renovation loans build on after-renovation value allowing homeowners with less home equity more options than most traditional renovation loans. 

• You’ve built equity
• A credit score of at least 640 (without recent bankruptcies)
• DTI ratio of 45% or below
• Steady source of income
• You’re looking to borrow $20,000 or more
• You’re current on mortgage payments for the last two years
• You have not listed your home for sale in the last six months
• You live in the home you’re planning to renovate (real estate and construction property as well)

Application Process

To apply for a HELOC, follow these general steps: researching and comparing lenders, completing the application, gathering the necessary documentation, property appraisal, approval and terms, and closing and disbursement. The lender will likely require a home appraisal to determine the amount of your credit line, which you may need to pay upfront. In most cases, your lender will schedule the home appraisal and you’ll pay the fee. But sometimes, the lender may pay for the appraisal and waive the fee if you keep the account open for a specified number of years.

Who is Best For A HELOC? 

• Homeowners Who Need Flexibility: When comparing HELOCs vs Home Equity Loans or Cash Out Refi or these loans allow homeowners to access funds only as needed during the draw period instead of all in one lump sum, paying interest only on the amount you draw (rather than the total in your credit line). This offers flexibility for ongoing or multiple home improvement projects, as well as any unforeseen changes along the way as the line of credit remains open until its term ends.
• Homeowners Looking For Competitive Interest Rates: HELOCs often offer competitive interest rates compared to other financing options for home improvements, but keep in mind, these can increase due to the nature of a variable interest rate. 
• Homeowners Interested In Potential Tax Advantages: There’s a chance that using a HELOC for qualified home improvements may be tax deductible, saving you money come tax time. To know for sure, consult a tax advisor.
• Homeowners Who Need More Budget Control: Since you can access funds as needed and set your repayment terms for minimum monthly payments or all at once, homeowners have more control over their funds and the management of their budget throughout the project. 
• Homeowners Who Want To Maintain Their Mortgage’s Interest Rate: The fact that HELOCs allow you to tap into your home equity as a separate loan from your primary mortgage is a major bonus for homeowners who have locked in a great interest rate. As a second mortgage, you won’t be forced to refinance which could lead to higher rates based on the current market.

Key Differences between HELOC and Alternatives

RenoFi HELOCs offer unique advantages compared to other financing options. Unlike a Cash-Out Refinance, HELOCs are separate loan that sits behind the primary mortgage. This allows homeowners to preserve favorable terms on their existing mortgage. Additionally, HELOCs typically have lower interest rates compared to credit cards or personal loans.

Nonetheless, The most common HELOC alternative is the Home Equity Loan - check out the table below which compares HELOCs vs Home Equity Loans below.

Benefits of Using a HELOC for Home Renovations

Utilizing a HELOC for home improvements comes with several advantages:

•  Flexibility: Access funds as needed during the draw period, providing flexibility for ongoing or multiple projects.
•  Competitive Interest Rates: HELOCs often offer lower interest rates compared to other financing options.
• Potential Tax Advantages: Interest paid on qualified home improvements may be tax deductible (consult a tax professional).
• Budget Control: Manage funds effectively by accessing them as needed and aligning expenditures with project milestones.

HELOC Expert Tip: One of the biggest disadvantages of a traditional HELOC for home renovation expenses is the fact that it only allows you to borrow based on the current value of your home, limiting how much you’ll have to cover your home wish list. RenoFi Renovation HELOC, on the other hand, all give you the ability to borrow against the after renovation value of your home, boosting this borrowing power significantly. 

Considerations for Using a HELOC for Home Improvement

To ensure a successful home improvement project with a HELOC, consider the following:

• Assess the project’s value and potential return on investment: Understanding the value your renovation will bring to your home can help you make informed decisions about allocating funds from your HELOC. Even though a HELOC gives you flexibility in regard if you’re not exactly sure how much you’ll need to borrow, the better you understand the renovation ROI you’ll get in the long run, the smarter your decision making will be along the way. 
• Create a comprehensive budget and plan: Outline the scope of work, research material costs, and obtain accurate estimates from contractors or professionals to effectively manage the funds borrowed through your HELOC. Make your budget plan as detailed as possible with an understanding that things may change and an emergency fund to protect yourself. Just like with a credit card, it can be easy to overspend with HELOC, so make a plan before your project starts to put yourself in the best position moving forward. 
• Consult with professionals: Seek guidance from contractors, designers , and loan advisors to understand the project’s scope, costs, and repayment plans.

HELOC Expert Tip: Seek out a loan advisor like RenoFi, which  offers a second set of professional eyes on everything your home renovation team provides — from contracts to specs to fees — to ensure everyone has your best interest in mind.

The Best Option For Home Improvement HELOCs

Now that we understand the benefits of a HELOC, let’s explore how homeowners can make the most of it for their home improvement projects. Traditionally, the maximum loan amount you can borrow will vary depending on the value of the property, how much you owe on it, and your creditworthiness. Some lenders will lend up to 80% of your home’s current value. For example, if your home is worth $350,000 and you owe $250,000, you could qualify for a HELOC of up to $30,000 - that isn’t much. One of the best way to get the most out of a HELOC to use a RenoFi HELOC.

HELOC to use a RenoFi HELOC.

With RenoFi loans, you can choose between a HELOC fixed rate or a variable rate loan of up to 90%of your home’s after-renovation value. Loan amounts range between $25,000 and $500,000, and you’ll have access to the full amount at closing.

RenoFi Renovation Loans not only boost your borrowing power based on the after-renovation value of your home, but they offer lower interest rates and monthly payments than most alternatives. And by partnering with awesome credit unions who help us offer these lower rates and give you even more flexibility based on your financial situation. Contact us today to learn more.