Home-equity lines of credit, which became scarce as banks pulled back and consumers grew wary during the housing market bust, are becoming widely available and popular again. But the new generation of these credit lines—known as HELOCs—carry restrictive features meant to lower the risk that the banks are taking. HELOCs are variable-rate loans that home owners can draw on as needed using their homes as collateral. Recent interest rates on HELOCs have been averaging below 5%. Banks are pitching HELOCs to home owners as financing to pay for college, consolidate credit card debt, make home improvements and provide a source of money for emergencies.
Features to watch out for…
Loan-to-value (LTV) ratio. The amount of money you can borrow with a HELOC now is limited to an amount that typically is based on an 80% LTV ratio. To calculate that, take 80% of your home’s appraised value, then deduct the outstanding mortgage amount. So even if you have equity in your home, you may not be able to borrow very much through a HELOC.
Example: If your home is appraised at $300,000 with a $230,000 mortgage balance, the most you qualify for is just $10,000.
Required credit score of 720 or above. Home owners with lower scores may qualify for an LTV ratio of just 65%.
Curtailment clause. Banks maintain the right to cut off your access to the HELOC just when you might need it most—if you get in financial difficulty, such as falling behind on your mortgage or suffering a large medical bill.
Important: If you have an existing HELOC with an interest rate that is higher than today’s going rates and your home has gone up in value, there is a good chance that you can refinance or modify the terms. Most HELOCs still are owned by their original lenders, which means there may be great flexibility in working with home owners, compared with those loans that have been sold off to giant banks.