HELOC Explained-What You Should Know

Whether you’re looking to make home improvements or make a major purchase, a HELOC may give you the flexibility to access funds for ongoing expenses.

A HELOC is a home equity line of credit that takes into consideration the equity you have in your home, then uses your home as collateral. You’re given a maximum amount of money you can take out of this account as needed. As you pay back the outstanding balance, your line of credit is replenished and available for further use.

How can you get a HELOC of your own? Here are three steps to help you get started.

This depends on your financial situation and personal financial goals. Ask yourself these questions to better understand your financial situation or talk to a financial advisor to get some clarity:

The answers to these questions should help you determine whether or not a HELOC is right for you.

Before applying for a HELOC, it’s a good idea to understand the necessary requirements for approval. This varies by lender, but there are a few things to consider:

Once you choose your lender, you’ll have to fill out a HELOC loan application online or over the phone. Applying for a HELOC is a lot like applying for a mortgage, so be prepared to provide the following documents:

If you’re still not sure if a HELOC is right for you, maybe it’s time to meet with a financial professional. You can confidentially discuss your current financial situation, how you can best use a HELOC and your financial goals. Mountain America Credit Union has an experienced, knowledgeable team waiting to guide you forward.

1. Decide if a HELOC is right for you

   • What can I afford?

     Your HELOC may have a minimum payment that’s due every month. Before you sign on the dotted line, calculate what your monthly payment will be and make sure it will fit comfortably into your budget.

   • What will I use it for?

     While some choices like education expenses and home improvements are a smart way to use the funds in your HELOC, other things—like a vacation—may not offer a long-term return.

   • Can I get approved?

     The answer to this question is all in the numbers! You’ll need to know how much equity you have in your home and what your debt-to-income ratio is. Then, check your credit history. You can get a free credit report once per year here. See #2 below for calculations.

   • Do I have a payback plan?

     Just like any other line of credit, you have to pay back the money that you use from your HELOC. Make sure you have a plan for doing so.

   • Can I stick to a budget?

     Once you have that plan, consider whether you will be able to stick to your budget to make monthly payments on your HELOC as well as repay the principal when the repayment period begins.

2. Understand the requirements

   • Equity—Estimate how much equity you have by subtracting the total amount you owe on your mortgage from the appraised value of your home. For example, if you owe $300,000 on your home, and the appraised value is $450,000, your home equity is $150,000.

   • Combined loan-to-value ratio (CLTV)—Another critical factor in obtaining a HELOC is your CLTV. This compares your home’s value to the total of all loans secured by it, including the HELOC amount. For example, if you apply for a HELOC of $50,000 and your loan balance is $300,000, your CLTV can be calculated by adding your loan balance and the HELOC amount together and dividing it by the current appraised value of your home. Once you have that value, convert it to a percentage. In this scenario, if your current appraised value were $450,000, your CLTV would be 77.77%.

     Most lenders require a CLTV ratio below 85% to qualify for a HELOC, but it can vary. It’s important to note that as the value of your home changes, so does your CLTV. If the value drops, you may not be eligible for a HELOC, or you could end up owing more than your home is worth.

   • Debt-to-income ratio—Your debt-to-income ratio (DTI) is the percentage of your monthly income that goes toward paying off debt. To calculate your DTI, add up all your monthly payments—including mortgage, car loan, child support and insurance. Divide this amount by your monthly personal gross income and convert that number into a percentage. It may vary by lender, but most require a DTI ratio of 47% or less to be approved. Lenders want to make sure you can afford to borrow more money while still keeping up with your previous obligations—so the lower the DTI, the better.

   • Credit score—Although it may not be the most important factor in qualifying for a HELOC, having a good or excellent credit score can make it easier for you to qualify, and can even better your interest rate. Shoot for a 645 credit score or higher.

3. Make sure you have the appropriate documentation

   • Proper personal identification

   • Your contact information

   • Proof of employment and identification

   • Documents for certain life events (i.e. child support, alimony, etc.)

   • Proof of homeownership

   • Homeowners insurance

   • Enough equity in the home to meet the loan to value requirement