The HELOC boom: With mortgage rates and home values on the rise, should you borrow against your home equity?
Home equity lines of credit, or HELOCs, are having a moment right now.
As mortgage rates have increased, homeowners looking to tap into their equity have had to look beyond cash-out refinances — and many have turned to HELOCs to get the cash they need.
Is a HELOC a good idea in 2023, and how can borrowers find the best HELOC lenders? Here’s everything borrowers should know about taking advantage of the current HELOC boom.
Why are HELOCs so popular right now?
During the pandemic, mortgage rates reached historic lows. At the same time, home values shot up. This gave homeowners great opportunities to tap into their newly-gained equity using cash-out refinance mortgages, which allowed them to take advantage of low mortgage rates while also using the cash in their home to achieve other financial goals.
But so far in 2023, rates have been much higher. This means that getting a cash-out refinance doesn’t make much sense right now, because most homeowners have locked in rates that are well below what they would get by refinancing.
To access the equity they have in their homes, many homeowners have turned to second mortgages, including HELOCs, which don’t require them to replace their mortgage and take on a higher rate.
With a HELOC, you’ll get a line of credit that borrows against your home equity. During the HELOC’s draw period, you can draw any amount of money from the HELOC, up to the credit line. The draw period typically lasts up to 10 years, depending on the loan.
Once this period is up, the HELOC enters the repayment period, where you’ll repay the loan and no longer be able to borrow from your line of credit. This period can be as long as 20 years.
The number of HELOC originations increased by 10.7% from 2020 to 2021, according to Home Mortgage Disclosure Act data.
Citizens Bank, one of the largest HELOC lenders in the country, has also seen an uptick in HELOC interest, says Adam Boyd, head of home equity and unsecured lending at Citizens.
“A HELOC became a really attractive option for customers looking to tap into that equity and do it in a way without disrupting the rate on the first mortgage,” Boyd says.
How much you could borrow with a HELOC
According to Boyd, the average credit line size a HELOC borrower gets is around $150,000.
“But most borrowers aren’t using the entire line amount,” he says. “The average utilization is on the order of 35% or 40% of the line amount.”
HELOC lenders typically allow combined loan-to-value ratios up to 80% or 90%. Your CLTV is the ratio that shows the balance of any loans you have on the property compared to the value of your home. So if your home is worth $500,000 and you still owe $200,000 on your mortgage, you have a CLTV of 40% (200,000/500,000=0.4).
To find out the maximum amount you could borrow with a HELOC, multiply your home’s current value by your HELOC lender’s maximum CLTV.
So, if your lender has a max CLTV of 80%, and your home is worth $500,000 with $200,000 remaining on your mortgage:
500,000 × 0.8 = 400,000
Then, subtract your remaining mortgage balance from this number.
400,000 – 200,000 = 200,000
In this example, you could get a HELOC with a line of credit up to $200,000.
Many homeowners may have access to even more cash, depending on how much of their first mortgage they have left to pay and how much equity they have.
Reasons to get a HELOC
Why are HELOCs potentially a good idea right now? One of the main draws of these loans is that they’re incredibly flexible.
Because HELOCs work similarly to credit cards, homeowners don’t need to borrow the full amount of credit they’re given by a lender. This can help you save on interest, since you’ll only pay interest on the money you end up borrowing, not the full amount you’re approved for.
You’ll also have that line of credit available to draw from over time as needed.
“We’ve seen customers repeatedly tap into their HELOC over time for various needs, home improvement, paying for large medical expenses, travel, what have you,” Boyd says. “Having that HELOC on hand gives you the opportunity to have immediate access to credit without having to go through a new application process every single time.”
Why get a HELOC over a home equity loan? Home equity loans can be a good option if you know exactly how much you need to borrow and you want the stability of a fixed rate and fixed monthly payment. HELOCs come with variable rates, which make them less predictable. But rates are expected to drop this year, which means getting a HELOC might be the smarter move.
“As rates start to come back down again, borrowers in a HELOC will automatically benefit from those lower rates, whereas borrowers who have financed into a fixed rate option would have to refinance out of that in order to benefit from lower interest rates,” Boyd says.
Shopping for a HELOC lender
Rates are often a big factor when shopping for a loan lender, and rightfully so, but they shouldn’t be the only thing you’re thinking about as you look for the right HELOC lender for you. Be sure to ask about the overall cost of the HELOC as well, including closing costs and annual fees.
You should also consider a lender’s reputation and any additional features or benefits it can offer you. For example, Boyd says that some HELOC lenders can take 50 days or more to close. So if speed is important to you, ask about average closing times.
Some lenders also offer special discounts to existing customers who already have checking or savings accounts with them. So as you start your search for a good HELOC lender, it might be worth checking out what your current bank offers.
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