The Essential Steps to Follow When Getting and Using a HELOC

If you're a homeowner looking to improve your property, consolidate high-interest rate debt, or fund an investment property, a home equity line of credit (HELOC, for short) may be a great way to secure funds at a reasonable interest rate. A HELOC is a line of credit, backed by your home as collateral. To qualify for one, you'll need to meet the lender's minimum requirements for credit score, debt-to-income ratio, home value and other factors.

If you meet those qualifications, you can generally borrow up to 85 percent of your home's value, minus the amount you still owe on the mortgage loan. For example, if your property is appraised at $800,000 and you owe $280,000, you would calculate 85 percent of the total value, which comes to $680,000. Then subtract $280,000 balance on your mortgage giving you a maximum HELOC credit limit of $400,000.

A HELOC can be a powerful tool to help you achieve your financial goals, whether you’re planning home renovations, consolidating debt, or funding education. At Bank of Hawaii, we’re committed to helping you reach your possible by providing the resources and guidance you need to make informed financial decisions.

HELOCs function much like a credit card: You can withdraw as many times as you like, within your credit limit. (Some lenders also have a minimum draw amount).  As any outstanding balances are paid, the amount of credit available is also replenished. However, this feature exists for a limited amount of time, called the draw period, which varies in length depending on the term set by the lender. During the draw period, you may only be required to make interest payments but can make additional payments toward the principal if you wish. After the draw period, you either enter the repayment period, during which you can no longer draw on the line and your required payments increase to include interest and principal, or you reach the end of the loan term, at which point the remaining balance of the loan is due (referred to as a balloon payment).

What makes HELOCs attractive to most homeowners is that typically they come with a low introductory promotional interest rate, which generally lasts for one to five years. After the promotional rate ends, the interest rate typically increases to a variable rate (aka the market rate) and fluctuates as the index rate to which the interest rate is tied to is adjusted. Typically your variable rate will include both the floating index portion and an additional "spread" above the index. Over the years, the interest rate on your loan may change many times—and not always in the direction you want.

As with any kind of credit, HELOCs can involve risk and complications. Fortunately, with a little research and planning, you'll be able to avoid some of the most common mistakes and make the best use of your line of credit.

Here's What You Need to Know:

1. Shop Around for the Best HELOC Deal

Not all HELOCs are created equal. It’s essential to compare offers from different lenders to find the terms that best suit your needs. Some lenders may offer low introductory rates, but these can increase significantly after the promotional period. Be sure to consider the following:

• Post-Introductory Rates: Understand what the interest rate will be after the initial period and whether it’s fixed or variable.
• Fees and Closing Costs: Factor in any additional costs associated with opening and maintaining the HELOC.
• Loan Features: Look for features like fixed-rate loan options or rate discounts for automatic payments that can provide added flexibility and savings.

By carefully evaluating these aspects, you can choose a HELOC that aligns with your financial objectives.

2. Budget and Plan Your HELOC from Start to Finish

Proper planning is crucial when managing a HELOC. Consider the following steps:

• Determine Your Borrowing Needs: Assess how much you need to borrow and avoid the temptation to max out your credit line. Borrowing only what you need can help you manage repayments more effectively.
• Develop a Repayment Strategy: Be mindful that initial payments may cover only interest, leading to larger payments later when principal repayment begins. Plan how you’ll handle these increased payments, considering potential future financial changes.
• Consider Life Changes: Anticipate any significant life events (e.g., children’s education, retirement) during the HELOC term that could impact your financial situation.

By setting a clear plan, you can use your HELOC responsibly and avoid common pitfalls.

3. Use Your HELOC Wisely

It’s important to use HELOC funds for purposes that add value or improve your financial health. Common beneficial uses include:

• Home Improvements: Investing in renovations can increase your property’s value.
• Debt Consolidation: Paying off high-interest rate debts with a lower-interest rate HELOC can simplify payments and reduce interest costs.
• Education Expenses: Financing education can be a valuable investment in your or your child’s future.

Avoid using HELOC funds for non-essential or depreciating assets, as this can lead to financial strain. For more insights on responsible HELOC usage, download our guide to learn how you can leverage your home’s equity to access the cash you need to achieve your goals.

Take the Next Step Today

Ready to explore how a HELOC can help you reach your financial goals? Connect with one of our local lending experts today to discuss your options and find a solution tailored to your needs and learn more about how to put your home’s equity to work.

At Bank of Hawaii, we’re here to support you every step of the way as you work to reach your endless possibilities.