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Home equity lines of credit (HELOCs) are an option for homeowners who want to tap the increasing equity in their home without refinancing their mortgages. And although rising interest rates might make HELOCs less attractive than before, they could still be a relatively inexpensive form of financing.
Current HELOC Trends
Many people took advantage of low interest rates to refinance during 2020 and 2021. However, even if their home's value has increased, they might not be able to buy a similar or nicer home today without making much higher monthly payments because of rising mortgage rates.
These "locked-in" homeowners might want to use a HELOC to invest in home improvement projects or cover other major expenses. And lenders might want to issue new HELOCs if their refinancing and new home loan businesses slows down.
Here are a few of the trends we're seeing with HELOCs in 2023:
- Higher balances that appear to be leveling off: HELOC balances, after declining throughout the pandemic, reversed the trend in 2022. While things have flattened a bit so far in 2023, according to Experian data, the total HELOC balance is still up year over year. As of July 2023, the total HELOC balance was about $324 billion, which is an increase from the July 2022 balance of $299 billion but still short of pre-pandemic levels.
- Credit limits increase: As home prices increase and homeowners pay down their mortgages, their equity increases. This can lead to an increase in HELOC credit limits, which are at their highest point since 2009.
- Available credit increase: Rising credit limits and relatively flat or declining balances also mean that homeowners have more available credit with their HELOCs.
- Introductory interest rate offers: Lenders may offer low introductory annual percentage rate (APR) offers, sometimes as low as 0%, for new customers. These teaser rates often only last for six to 12 months.
Some of the major banks never returned to the HELOC market after stopping their loan programs in 2020 and 2021. However, other lenders and financial technology firms are stepping in, and some offer completely online processes that allow borrowers to get funding in as few as three to five business days.
How Do HELOCs Work?
A HELOC is a secured revolving credit line that uses your home as collateral. Similar to getting a credit card, a HELOC allows you to repeatedly borrow money, or draw, until your total balance reaches your account's credit limit. You'll only pay interest on the amount you choose to borrow.
A few important things to keep in mind about HELOCs are:
- There may be separate borrowing and repayment periods. Your HELOC starts with a draw period—a five- to 10-year period when you can borrow against the credit line and only have to make interest payments. Once the draw period ends, you'll need to start making full monthly payments over the repayment period, which could last for up to 20 years. Alternatively, you may be able to renew or refinance the HELOC.
- Your credit limit depends on your equity. HELOCs generally let you borrow up to 85% of your home's value minus what you owe on your mortgage, although some lenders may have lower or higher limits. For example, if your home is appraised at $400,000, you owe $300,000 on your mortgage and you get approved for 80% equity, your HELOC's limit will be $20,000: (400,000 x 0.8) - 300,000.
- HELOCs often have variable interest rates. Your interest rate and the resulting monthly payment could change after you open your initial draw. There may be minimum and maximum potential interest rates, but rising rates could still increase your overall cost of borrowing. Although they're not as common, some HELOCs have fixed rates that give you the option to take fixed-rate draws or allow you to convert draws into fixed-rate loans.
- There are fees. You may have to pay a variety of appraisal, application and closing costs to get a HELOC. Additionally, there could be annual fees, inactivity fees, cancellation fees and draw fees.
Even though HELOCs are secured by the value of your home, they tend to require a good credit score. The rate you receive can also depend on your income, debt-to-income (DTI) ratio, loan-to-value (LTV) ratio and how much you borrow when you take a draw.
Should You Get a HELOC in 2023?
A HELOC might be a good option if:
- Your home's value increased. Rising housing prices mean you'll have more equity in your home and may qualify for a higher credit limit. But you might be able to get a lower rate if you accept less than the maximum your lender allows. Prices don't always go up, however, and you could wind up underwater (owing more than the house is worth) if the market drops.
- You think interest rates will drop. Taking on a variable-rate loan always comes with a bit of risk. But a HELOC could be a good option if you can get a low promotional rate and think interest rates will drop before your HELOC's standard variable APR starts.
- You have a home improvement project. A home equity loan or HELOC could be a good option for home improvement projects because the interest payments may be tax-deductible.
- You want a credit line just in case. If you can find a HELOC with low or no closing costs, maintenance and inactivity fees, you could keep the line open just in case an emergency arises. However, lenders can lower your credit limit, freeze or close your HELOC.
But HELOCs aren't great for everything. For example, you might not want to use your home as collateral to borrow money for a vacation or purchase investments. And drawing from a HELOC to consolidate credit card debt might help you save money and pay off the debt; however, as with your mortgage, falling behind on HELOC payments could lead to foreclosure.
Alternatives to HELOCs
HELOCs aren't the only way to finance major purchases, and other options might be a better fit in certain scenarios. Consider these secured and unsecured alternatives.
Home Equity Loans
A home equity loan (HEL) is an installment loan that uses your home as collateral. Similar to HELOCs, the amount you can borrow depends on your equity in the home. However, HELs tend to have fixed interest rates, and they could be a better option than a HELOC if you need the entire loan amount upfront.
Cash-out refinancing is when you refinance your mortgage, borrow more than your outstanding balance and keep the difference as cash. Most homeowners who recently got a mortgage or refinanced might not want to refinance into a higher-rate mortgage, which is where HELOCs and HELs come in. However, even if market rates are higher, you might qualify for a lower rate or monthly payment if your credit or finances have improved or refinancing will get rid of your mortgage insurance.
A personal loan is an unsecured installment loan, meaning you qualify based on your creditworthiness and don't offer the lender any collateral. While personal loans may have higher rates than HELOCs, they tend to offer fixed rates that can still be fairly low. Some personal loans have origination fees, which are often a percentage of the loan amount. But these might be lower than closing costs for a HELOC, and there are fee-free options for borrowers who have good credit.
Credit Cards With Introductory Offers
Credit card issuers may offer current and new cardholders promotional APRs on purchases or balance transfers. You could open a credit card with an intro 0% APR offer, make major purchases or transfer funds to your bank account, and then pay down the balance while you aren't accruing interest. Some of the best credit card offers come with a 21-month intro 0% APR period.
Monitor Your Credit and Financing Options
Your credit history and score can greatly impact your financing options and the offers you receive. Get your credit report and score for free from Experian with ongoing credit report and FICO® Score☉ tracking. You can also use Experian CreditMatch™ to compare personal loan and credit card offers based on your credit profile.