Home Equity Line of Credit Calculator

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How do HELOCs work?

A HELOC is a revolving, open line of credit. It works much like a credit card — you are able to use it as needed, repay the funds and then tap it again. However, a HELOC has some benefits over credit cards. One is that the amount you can borrow on your HELOC is likely to be higher than the balance limit on your credit card (think five figures instead of four). Another is that HELOCs currently have single-digit interest rates, compared to the 16 percent or more you’ll pay if you carry a balance on a credit card.

HELOCs generally have a variable interest rate and an initial draw period that can last as long as 10 years. During that time, you can make interest-only payments. Once the draw period ends, there’s a repayment period, during which interest and principal must be paid. You can no longer withdraw funds.

A word of caution: With a line of credit, it can be easy to get in over your head by using more money than you are prepared to pay back. The variable payments can also create financial challenges. 

What are the pros and cons of a HELOC?

Pros

  • Lower APRs than credit cards
  • Tax-deductible interest (depending on use of funds)
  • Flexible withdrawals and repayments
  • Potential boost to credit history
  • Less paperwork and fees than a cash-out refinance

Cons

  • Higher APRs than mortgages
  • Home becomes collateral for the loan
  • Borrower’s home equity stake is reduced
  • Interest rate and monthly payments could rise
  • Potential to run up big balance quickly

What are HELOCs used for?

You can use the proceeds from your HELOC for anything. That’s a lot of financial freedom, so it’s useful to have some guidelines about how to spend the money. A few options, and whether they make sense:

  • Home improvements and repairs: Yes. Using home equity to pay for kitchen renovations and bathroom updates is a no-brainer. These upgrades add to functionality and (generally) the resale value of your home. If you need a new air conditioner, for example, a HELOC is cheaper than carrying a credit card balance. However, be careful about using HELOCs to add a swimming pool or tennis court — these additions are expensive, and homeowners usually don’t recoup the full amount of the investment.
  • Consolidating debt: Maybe. If you’re carrying credit card debt and paying double-digit interest rates, it could make sense to swap out expensive revolving debt for cheaper HELOC debt. This strategy comes with a big caveat, however: Pull cash out of your house to pay off the credit cards only if you’re not going to simply run up more debt. Otherwise, you’ll have the unfortunate combination of less home equity and an overhang of credit card balances.
  • Investing: Probably not. Tapping home equity at 3 percent to fatten up your retirement savings made sense. However, using a home equity line of credit at 7.5 percent today probably isn’t ideal.
  • Paying down student loans: Maybe. This one is a bit of a gray area. If you owe student loans from private lenders, it can make sense to pay those down by tapping home equity. In contrast to federal loans, private student loans carry higher rates and less flexibility. Federal loans have lower rates and more safeguards around financial hardships, so there’s no hurry to pay them down.
  • Going on vacation or buying electronics: Hard no. Real estate is a long-lived asset that will give you years of use and almost certainly gain value. A Caribbean cruise or a gaming console, on the other hand, will be long forgotten even if you’re paying it off for decades. If a HELOC is your only option for paying for a vacation or another big-ticket item, better to put the purchase on hold.
See also  Home improvement

Factors that affect your HELOC payments

APR

HELOCs typically have variable rates, and the most relevant figure to you as a borrower is the APR, or annual percentage rate. It’s not uncommon for lenders to offer a low promotional rate for six months to a year. Your APR then will adjust to the market rate. After that, your HELOC rate will move up and down with interest rates.

The age of the loan

HELOC repayment is unusual in that not only will your required payments change over time, the method used to calculate those payments will also change. Typically, a HELOC has two distinct stages: a draw period and a repayment period. The draw period is the first stage, usually lasting between five and 10 years. During this period, your minimum monthly payments will be equal to the amount of interest that accrued that month. That means the interest rate of the HELOC and its current balance will determine the payment.

As you draw more funds from the line of credit, the amount of the minimum payment will rise (even though it only covers accrued interest, that interest is applying to a larger balance). Changes in the interest rate will also change your required payment. With most HELOCs, you can also opt to pay more than the minimum, to lower outstanding the balance during the draw period.

Once the draw period ends, you’ll enter the repayment period. During this phase, which can be as long as 20 years, you’ll have to make payments that cover interest and a portion of the loan’s principal. That means your payment will increase when the draw period ends and the repayment period begins.

Rate Caps

Be sure to find out the maximum interest rate on your HELOC. HELOCs carry lifetime interest rate caps — so even if the prime rate rises and surpasses your rate cap, your HELOC rate by law can’t increase any further. If you have an existing HELOC, you can attempt to negotiate a lower rate with your lender. “Ask your current HELOC lender if they will fix the interest rate on your outstanding balance,” says Greg McBride, chief financial analyst at Bankrate. “Some lenders offer this, many do not. But it is worth asking the question.”

See also  Pros And Cons Of A Home Equity Line Of Credit (HELOC)

What is a fixed-rate HELOC?

Lenders have begun to offer a new type of HELOC, one with a fixed rate. It allows you to freeze a portion or all of your balance at a non-fluctuating interest rate. This type of HELOC protects you from upward moves in interest rates, allowing for more stable monthly payments. Of course, if interest rates fall, you won’t benefit from the decline, either.

Home equity loans vs. HELOCs

Home equity loans and HELOCs are two types of loans that use the value of your house as collateral. They’re both considered second mortgages. The main difference between them is that with home equity loans you get one lump sum of money whereas HELOCs are lines of credit that you can draw from as needed.

With a home equity loan, you have a set repayment period and a fixed interest rate, meaning your monthly payment will never change. If you’re looking to spend as you go — and only pay for what you’ve borrowed, when you’ve borrowed it — a HELOC is probably a better option. Conversely, if you know exactly how much you need upfront, a home equity loan could be a better option than a HELOC.

HELOC vs. mortgage refinance

A HELOC isn’t the only way to tap your home equity for cash. You also can use a cash-out refinance to raise money for renovations or other uses. A cash-out refi replaces your existing mortgage with a new mortgage that’s larger than your current outstanding balance. You receive the difference in a lump sum of cash when the new loan closes. Many lenders let you refinance and borrow up to 80 percent of your home’s value.

In 2021, when mortgage rates were at record lows, the smart move was to take a cash-out refi and lock in a super-low rate. However, the sharp runup in mortgage rates in 2022 and 2023 makes a cash-out refinance an unattractive option – you trade in your entire mortgage balance for a new rate. If you locked in a mortgage rate of 3 percent, for instance, a new cash-out refinance now likely won’t make sense.

A HELOC lets you keep your old mortgage intact. So only the new funds you draw from it are based on higher rates. A HELOC also tends to come with fewer fees and closing costs than a cash-out refi.

Refinancing your HELOC

HELOC payments tend to get more expensive over time. There are two reasons for this: adjustable rates and entering the repayment phase of the loan.

HELOCs are variable-rate loans, which means your interest rate will adjust periodically. In a rising-rate environment, this could mean larger monthly payments.

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Additionally, once the draw period ends borrowers are responsible for both the principal and interest. This steep rise in the monthly HELOC payment can be a shock to borrowers who were making interest-only payments for the first 10 or 15 years. Sometimes the new HELOC payment can double or even triple what the borrower was paying for the last decade.

To save money, borrowers can refinance their HELOC. Here we’ll take a look at two options and how they work.

  • Home Equity Loan – You can take out a home equity loan, which has a fixed rate, and use this new loan to pay off the HELOC. The advantage of doing this is that you could dodge those rate adjustments. The disadvantage is that you would be responsible for paying closing costs.
  • New HELOC – Apply for a new HELOC to replace the old one. This allows you to avoid that principal and interest payment while keeping your line of credit open. If you have improved your credit since you got the first HELOC, you might even qualify for a lower interest rate.

If you’re interested in refinancing with a HELOC or home equity loan, use Bankrate’s home equity loan rates table to see current rates.

Refinancing your HELOC into a home equity loan

 Some HELOCs give you the option, when the draw period ends, to refinance into a fixed-rate debt product — a home equity loan. (You can also look into doing this during the draw period, of course.) If you’re looking for certainty around payment amounts and interest rates, it might make sense to refinance a HELOC into a home equity loan.

The advantage of doing this is that you could dodge those rate adjustments. The disadvantage is that you would incur closing costs on the home equity loan.

Paying off a HELOC

With a HELOC, you only owe (and accrue interest on) what you actually borrow. For example, if you’re extended $50,000 and use just $25,000, then you only owe $25,000.

During the draw period, you have several repayment options. Many HELOCs allow borrowers to make interest only payments during the draw period, which can vary. But of course you can make more than the minimum payment, if you choose — decreasing the outstanding balance on the credit line.

Normally, draw periods last between 10 and 15 years. When that period ends, you must make both principal and interest payments.

HELOC repayment periods can last for decades. You have the option to repay on that schedule, or you can try to pay it off sooner, and terminate the arrangement. You might even pay it all off during the draw period, if you’re confident you won’t need any more funds. However, some HELOC lenders charge a fee for ending early; these  prepayment penalties are usually a few hundred dollars. Before you commit to a line of credit, be sure you read and understand the fine print. — that’s where prepayment fee info is usually buried. By law, lenders have to indicate if they impose one, but bear in mind that it could be called something else, such as an “early termination fee.”

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