A home equity loan of credit (HELOC) is a mortgage you can use to access the equity in your home as needed or as part of your financing plan when you purchase a home. Let's look at how a HELOC might be used and obtain one if it is the right loan for your needs.

HELOC For Home Equity Access

Home equity lines of credit do exactly what their name suggests: They allow you to have a maximum credit limit to access your home equity whenever you need it using a checkbook, credit card, or bank account. For example, a home equity credit could be used as a first mortgage if you own your $400,000 home. The maximum credit limit you have available to you might be $200,000; this will allow you to access half your equity while preserving the rest.

In this case, the maximum balance is $200,000. You can access some or all of the money, pay it off, and then get it back again. You wouldn't be billed if you didn't use any $200,000 of it. You only pay for what you use. Bills are sent every month. HELOCs may only require interest payments on outstanding balances, while others require both principal and interest payments. After you locate a HELOC lender, they will be able to brief you about HELOC payment options.

A HELOC can be used to access your home equity if you have a $200,000 first mortgage on your $400,000 house. Lenders require that your total first mortgage amount plus your HELOC balance be at least 90 percent of the home's actual value. Your maximum HELOC limit for a home worth $400,000 would be $160,000

A HELOC lender may allow your first mortgage and your maximum HELOC to exceed 90 percent of the value of your home. However, this will depend on the state of the U.S. housing market at that time. As a result, your loan-to-value ratio can rise depending on the market and economic conditions. However, 90 percent is a standard cap that most lenders have maintained even in difficult times. This allows for some cushion in the event your home's price drops.

HELOC Home Purchase

HELOCs can be used to refinance existing homeowners' equity. However, they are also useful for financing a home. This is the most common use of a HELOC to finance a home purchase.

You could finance the entire 90 percent of a $400,000 home purchase with only 10 percent down. However, if you have a second mortgage, you will be required to pay mortgage insurance. By limiting the amount of your first mortgage to 80 percent of the purchase price and getting a second mortgage for the remainder, you can avoid the need for mortgage insurance. The second mortgage could be either a fixed-rate mortgage or a HELOC that adjusts monthly.

A fixed-rate second mortgage may be a better option if you are unsure if you can afford the monthly payments and you don't intend to make it pay down. On the other hand, a HELOC is a better option if you want to quickly pay off the second mortgage and then use the money to build equity in your home. Your HELOC lender can help you decide.

How Do You Qualify For A HELOC

A HELOC qualification is similar to a traditional loan. However, lenders will assess your credit, ability to repay, and down payment (if buying), as well as equity (if a homeowner).

Two factors influence your credit quality.

Your credit score is a representation of your credit quality. Your credit score can determine whether you are eligible for a HELOC. However, if your score is lower than 600, your rate may not be as high. This is because HELOC rates heavily depend on credit scores. HELOC rates that are the best will only be available to those with 740 credit scores or more.

Your credit history is what tells your lender how punctual you have paid your bills in the past. As a result, you will be eligible for a rate adjustment depending on how recent and severe late payments have been.

HELOC rates and eligibility are affected by the equity in your home. This assumes a maximum HELOC balance. For example, the rates for a HELOC that uses 50% of the value of your home versus one that uses 90% of it will be lower than those that use 50%. You might not be able to qualify for a lender if you exceed 90 percent.

The lender will calculate how much of your monthly income goes to housing and other bills to determine your ability to afford it. A HELOC will allow you to pay interest only, but the lender will still qualify you by charging a higher monthly payment. This is because the HELOC's adjustable rate means that it could go higher in the future.

Different lenders calculate this payment differently. However, a common way to calculate the "worst-case" payment is to use a 20 year fully amortized payment on the maximum HELOC. This may make it harder to qualify and could result in you being eligible for less HELOC maximum.

How To Apply For A HELOC

It doesn't make a difference how you apply for a home equity loan or a traditional mortgage.

First, search for a HELOC lender. They'll either take your application in person or instruct you to complete an online form. The lender will ask for the following information:

• Contact information, including name, email, phone number, ages, school years, ethnicity, and the number of children.

• Documentation and a minimum of two years' residence history.

• Minimum of two years employment history and income history.

• A minimum of two months' worth of statements is required for all investment and bank accounts.

• Written authorization from the lender to pull credit reports and social security number

• Documentation for life events such as divorces, child support, bankruptcies, and alimony.

• Documentation of all payments, insurance, taxes, and income for properties that you own.

This may not all be necessary at the beginning, but it will become essential later.

You should shop around for the best rates and fees, just like with any loan. Ask for information about closing costs when you receive a HELOC quote from a lender. These are typically slightly less than traditional loans but can still cost hundreds of dollars. These fees can be paid in cash at closing or added to your HELOC account. If you do so, you will have a payment on the HELOC within 30 days of closing.

HELOCs may also have annual maintenance fees, just like credit cards. They can also be subject to an early closure fee if they are closed within the first one or three years. When you receive your quotes, ask your lender for this documentation.