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Home Equity Lines of Credit – Something to Consider?

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Recently a relative of mine decided to convert a portion of her home into a small rental unit. The goal was to earn some extra money while renting out the space to someone she knew. Unfortunately it hasn't turned out as well as planned.

Now she's stuck with a place that needs work done to get it properly finished and since she is limited in funds, she's looking at getting a loan to cover these expenses. The good news is that it doesn't look to be huge, but it is more than what she currently has in savings.

She's thinking about getting a HELOC as a possible option.

What is a Home Equity Line of Credit?

As the name suggests, a home equity lines of credit (or HELOC) is a line of credit based on the equity you’ve accumulated with your property. Some borrowers use HELOCs to consolidate their debts and pay them off faster. Others use it for home improvement projects.

Lenders calculate equity based on what your home is worth and what you owe on the mortgage loan.

How is HELOC Calculated?

Banks are more careful with how they calculate HELOCs, but it's still possible to open an account if you have a good or excellent credit report.

Let's say you have a home that is appraised at $200,000. Your mortgage on it is currently $130,000. You could qualify to borrow as much as $30,000.

For one bank that loan amount would be broken down at $206.25/month at 8.25% for 3 years.

Checking Wells Fargo, the lender offers this advice on how much to request for a HELOC:

To improve your ability to qualify for a Home Equity Loan or Line of Credit, your loan or line of credit amount plus your current mortgage balance should not exceed 80.00% of your home’s value — your Combined Loan to Value ratio (CLTV).

It's a buffer for them, and believe it or not, you. Should your property value drop too much, it can be a huge problem.

Don't Get Burned

Both HELs and HELOCs use your house as collateral. That’s a risky proposition,though, because if you can’t make payments on all of the lenders, technically any of them can foreclose on your home. Lenders also have the ability to reduce your line of credit as well, so please be careful.

Not knowing my relative's financial state, I can't say if this is a good option for her or not. If she asks for more help from me, I'm going to suggest that she look at the cold, hard numbers before she signs up for either option.

Thoughts on Home Equity Loans & Home Equity Lines of Credit

Have you ever had to get a HELOC to cover a renovation or repair? Have you used a HELOC as an emergency fund? How did it work out for you?

Photo Credit: Images_of_Money

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