How Does a Home Equity Line of Credit Work?

Like a credit card, some lenders issue plastic debit/credit cards or checks that you use to draw funds directly from your home equity line of credit account. Not here in Texas! It's actually not allowed by state law. In Texas, the borrower requests a draw of at least $4,000 to be transferred to their account where the funds can be accessed as normal. You can then use your debit card or personal checks to buy things with that money.

Only Pay Interest on What You Borrow

With a HELOC, you as the borrower are in control of how much and how often you withdraw – and how fast you pay it back. The other cool feature is that you can re-borrow funds as you pay your HELOC balance down without having to re-apply for a new loan. Technically, you can have a home equity line of credit and never draw from it. Therefore you would never pay interest unless your lender requires an initial draw upon approval (this varies by lender).

Note: If your credit cards tend to carry high balances, you may want to opt for a home equity loan rather than being tempted by a revolving Home Equity Line of Credit.

Interest Rate Variability

HELOCs have variable interest rates like credit cards or adjustable rate mortgages. The interest rate fluctuates based on the prime rate, the industry standard and you may be approved for a certain number of points above that or below that. The good thing about a HELOC is that they are usually offered at lower rates than most forms of credit, which is why a HELOC is often used to consolidate high-interest rate credit cards and student loans. You also may want to talk with your tax advisor before applying, because another possible HELOC benefit is the ability to deduct the interest on your tax returns—you won't be able to do that with a credit card.

Reminder: You are only charged interest on the funds you actually draw, once you put that money back into the account, you no longer pay interest on it.

Drawing and Repaying on your HELOC

Once you get approved for a HELOC, you can start using it right away. The ability to take advances from the line of credit is referred to as the draw period. Most lenders will allow you to make interest-only payments during this period. The lender will establish the parameters of this period, which can be from 5 years all the way to 20 years. You will notice with HELOCs numbers like 5/15 or 10/10. The first number refers to the number of years the draw period is set on the account and the second is the years of the repayment phase. The repayment period or phase of the loan happens when the draw period ends (5-10 years). During the repayment phase, you can no longer draw from your line of credit and have to start paying back the principal loan. It will be spread out into monthly payments over a set period of years where you have to pay both principal and interest. The loan must be paid off by the established pay off date.

Reminder: According to Texas state law every draw from your HELOC must be a minimum of $4,000.

How to Qualify and Apply for a HELOC

You don't need to use the same lender you have for your mortgage for your HELOC, which is why it is good to do your research and shop around. First, you have to figure out how much equity is in your house (the fair market value of your home minus how much you owe on your mortgage plus any other liens you may have). Moreover, since you live here in Texas, the state requires that you can only take out a home equity loan or HELOC if what you owe on your mortgage (plus any lien) is 80% or less from the appraised value of your home.

Note: As the equity in your home grows, so can your line of credit. You can refinance your HELOC every year if you want.

Like Home Equity Loans, HELOCs are only available if the property is your primary residence. Many people think they can take a HELOC on a rental property or a vacation home -- but you can't.

Once you figure out that you have enough equity built in your home to borrow against, then you will have to fill out an application. It is similar to when you refinance your mortgage in that you have to have documented proof of your employment and income, your credit score, and any outstanding debt.

The CUTX Difference

As you may already know, credit unions are a great way to save money on financial services. Like other credit unions, CUTX has very competitive prices when it comes to most financial services including home equity loans and home equity lines of credit. Unlike other major lenders where you have multiple fees tacked on to your line of credit (i.e., title search fee, application fee, annual fee, and early closure fee), CUTX has no such fees for HELOCs under $200,000. If you need a new appraisal, then you'll have to pay for that, but many times a new appraisal isn't required. Also, there are no prepayment penalties (you can always pay extra) or early closure fees with CUTX. Do you have any other question about home equity lines of credit? Call the Credit Union of Texas(CUTX). You can speak to a CUTX equity expert by calling us at 972-705-4845 or check us out on the web at CUTX.org.