A home equity line of credit lets you access the capital you have accrued in your home over the years. Building home equity gets you closer to becoming debt-free, but you may need those funds to cover vacations, medical bills, college tuition, and other costs.
The maximum amount of money you can borrow depends on several factors, such as your mortgage’s current balance and your property’s fair market value. This guide will explore how much money you can tap into with a HELOC.
What is a HELOC?
A HELOC is a credit line that uses your property as collateral. You have to make the minimum monthly payment on your HELOC, which is typically more generous than a home equity loan. You can borrow against your HELOC throughout its draw period, which ranges from 3 to 10 years. If you pay off the HELOC in full before the draw period, you can still borrow against the credit line if you need extra cash.
The Basics of Home Equity Lines of Credit (HELOC)
A home equity line of credit lets you tap into the capital you have built up in your home. Homeowners accumulate equity with monthly mortgage payments and when their properties appreciate. Most HELOCs have variable interest rates, which means they can fluctuate as market conditions change.
You can use a HELOC to make any purchase. It can be used to cover home improvements, vacations, and any other personal expenses. You do not have to tell a lender how you intend to spend the funds.
Calculating Your Home Equity
HELOCs let you borrow money against your home equity. Knowing how much you have will give you a better understanding of how much you can borrow. You can use this approach to arrive at your home equity.
Understanding Home Equity
Home equity is the amount of value you have built in your home. You can borrow from your home equity or continue to accumulate it. Eventually, You can become debt-free if you do not borrow against your home equity and continue making monthly mortgage payments. Making an additional mortgage payment each month can build equity faster since you pay off the principal with that second payment.
How to Calculate Home Equity
Home equity is the difference between your property’s fair value and your mortgage balance. If a property is worth $1 million and you have a $300,000 mortgage, you have $700,000 in home equity. Mortgage lenders will request that you conduct an appraisal to determine the current market value of your property instead of using an arbitrary number.
How Much HELOC Can You Get?
The amount you can borrow from a HELOC depends on a few factors. Here’s what you should keep in mind before starting the process.
What is the Maximum You Can Borrow on a HELOC?
The maximum you can borrow depends on your mortgage balance, the property’s value, and your lender’s LTV ratio limit. The loan-to-value ratio measures your property’s debt as a percentage of the home’s value. If you have a $600,000 mortgage on a $1 million home, you have a 60% LTV ratio.
Most lenders cap your combined LTV ratio at 80%. In this scenario, you can borrow up to $800,000 against the property from earlier. Since the home already has a $600,000 mortgage, you can only borrow an additional $200,000, which will bring you to a combined 80% LTV.
Limitations on HELOC Amounts
The 80% LTV ratio is a hard cap for some lenders, but others give you more flexibility. Some lenders set higher LTV maximums that can get as high as 95%. The homeowner in this same example can borrow up to $350,000 instead of $200,000 if the lender allows them to have a 95% LTV ratio.
Factors that Determine How Much Money You Get
These factors influence the amount you can borrow against your property through a HELOC.
Your Home’s Value and Amount of Equity
A higher home value and more equity will increase how much you can borrow from your HELOC. A higher valuation means you can borrow more money before reaching the 80% LTV ratio threshold that many lenders use.
The Interest Rates
Higher interest rates will limit how much money you can borrow with a HELOC. Higher rates result in higher monthly payments, which can result in a higher DTI ratio than most lenders would like. Lower interest rates make it easier to borrow more money for a HELOC.
The Outstanding Mortgage Balance
A higher mortgage balance indicates that you don’t have as much equity in your home. This dynamic can result in a lower HELOC limit and restrict your access to additional capital. Homeowners who have made monthly mortgage payments for several years will have more equity readily available.
Your Credit History
Mortgage lenders want to make sure you can keep up with the monthly payments. Even though you build equity with mortgage payments and appreciation, lenders can still reject your application if your credit score is too low. You can get a HELOC with a 620 FICO score, but you will significantly improve your chances if you have a 680 FICO score or higher.
Your DTI Ratio
Your debt-to-income ratio measures your debt as a percentage of income. If you make $10,000 per month but pay $8,000 per month in debt, you have an 80% DTI ratio. Mortgage lenders will not work with borrowers who have that ratio. The limit most lenders establish ranges from 43% to 50%. You can reduce your debt-to-income ratio by making more income, paying off debt, or refinancing your debt so you end up with lower monthly payments.
Tips for Increasing Your HELOC Amount
These are some of the strategies you can use to get a higher credit line from your home equity.
How to Increase Your Home’s Value
Home improvements can raise your property’s value and result in more equity. If you don’t want to put in sweat equity, you can also wait for your property to appreciate and then have an appraiser value your home.
Paying Down Your Mortgage to Increase your HELOC Amount
Paying off your mortgage increases your home equity, but you don’t have to stop with one monthly payment. Making an additional payment each month can get you out of debt much sooner and allow you to borrow more money for a HELOC.
Mortgage lenders use an amortization schedule that front-loads the interest payments. Most of your monthly mortgage payments during the first few years go toward interest. It’s only near the end of your mortgage’s term when most of the payments go toward the principal. A bonus monthly mortgage payment bypasses the amortization schedule and lets you pay off your principal sooner.
Use Airbnb
If you have empty rooms in your home, you may want to consider listing your property on Airbnb. This strategy adds the complexity of having roommates, but you can make a solid monthly income with your property. The extra cash from Airbnb can go right back into your mortgage and build equity in your property.
Advantages and Disadvantages of HELOC
These are the pros and cons to consider before getting a HELOC.
Advantages
- Access extra capital
- More flexible repayment schedule
- Lower interest rates since your property is collateral
Disadvantages
- Closing costs
- Additional debt
- Interest accumulation
How the HELOC Application Process Works
Mortgage lenders will request basic documents like your ID, Social Security Number, proof of residence, and proof of income. After reviewing this information and running a hard credit check, lenders will let you know if you are approved. You will then learn how much capital you qualify for.
It is a good idea to apply for HELOCs at multiple lenders instead of immediately working with your current lender. It’s possible that your current lender has the best rate and terms, but you’ll never know if you don’t reach out to other lenders. Online lending marketplaces allow you to quickly get in front of dozens of mortgage lenders who may offer better rates and terms than your current loan provider.
Conclusion: Maximizing the Money You Can Get with a HELOC
A HELOC helps with any expense. Banks let you use the money in any way that you desire. While it’s good to focus on paying off your mortgage if you don’t need the extra funds, it’s good to have home equity readily available just in case.
Making extra mortgage payments and improving your property can accelerate home equity growth. Home equity doesn’t grow significantly within a year, but it can compound tremendously over several years.
You never know when you may need a HELOC, and it’s possible that you never have to take out a credit line against your home. However, building up home equity also trims your mortgage balance and increases your wealth. Maximizing the money you can get with a HELOC will also move you closer to your long-term financial goals.
