A HELOC, or home equity line of credit, is a financial vehicle that may allow you to pay off your home faster than you thought possible, become debt free, and obtain financial freedom. It’s a loan that’s set up like a line of credit where you can draw money from it – up to a certain dollar amount – and use it like a checking account. There’s a draw period, then a repayment period, usually lasting 10 to 20 years.
If you’re wondering about how much you can borrow with this financial approach, you’re in the right place.
First, it’s important to understand that all home equity loans and HELOCs are secured by the equity you have in your home. That means you’re using your home’s equity as collateral. Because of this, you’re likely to get a lower interest rate than you could with another credit card or other type of unsecured loan.
In the past, homeowners could borrow up to 100 percent of their equity – but that’s changed in recent years. Now, lenders limit the amount you can borrow, and that ranges from 80 to 95 percent of your home’s appraised value based on your credit profile.
Your equity is determined by taking your home’s current appraised value minus what you owe on your mortgage. Here’s an example. For a home worth $300,000 and a balance of $150,000 left on the mortgage, there’s $150,000 of potential equity.
Calculating Your Maximum Line of Credit
Here’s where a HELOC differs from a home equity loan (HEL). With an HEL, you’d be limited to 80-95 percent of $150,000. However, with a first-position HELOC, you can take out a line of credit worth 80 to 95 percent of your home’s total appraised value. The total will be based on your credit score and DTI (debt-to-income ratio), which typically must be under 45 percent to qualify.
If in this scenario above your lender allows you to borrow 95 percent of your home’s equity, then you take your home’s value ($300,000) multiplied by .95 (the percentage your lender will let you borrow). Then subtract what you currently owe on your mortgage ($150,000), because you’ll be paying it off – and the first-lien HELOC will be your only loan.
- $300,000 x 95% = $285,000
- $285,000 – $150,000 = $135,000, the remaining amount available on your line of credit
- Once you’ve paid off the $150,000 that remains on your mortgage with the HELOC, that’s the balance you’ll owe on the HELOC. At that point, you’ll start using the strategy we outline here.
How much you can borrow is based on combination of how much your home is worth, your overall debt-to-income ratio, and your credit score. Again, every lender’s requirements and scenarios are different – and so is your unique financial situation, which always comes into play.
How Much Do You Need to Borrow?
Before you consider what amount of equity you can get out of your home, it’s also important to consider your plans for the financial flexibility afforded by a HELOC. That means having a clear understanding and plan for what this money will do for you. If you’re considering home improvements like renovating your bathroom or building a patio, we’d strongly encourage you to pay off your mortgage first, and then pay down the HELOC balance to get out of debt.
Whatever your priority, after you pay off the balance, you won’t have a house payment each month. That freed-up income can then be used to cover a number of expenses that are planned and unplanned – like college tuition or unexpected medical costs.
A first lien HELOC (one that takes the place of your mortgage) can be a way to put your whole paycheck to work each month to pay down your mortgage fast.
Click here for a HELOC calculator to help you understand what it will take to pay off your line of credit and what you can change to meet your repayment goals.