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If you are a homeowner and need money for a vacation, home improvements, debt consolidation, or to pay off credit card debt, you might be considering a home equity line of credit (HELOC). The HELOC lets you borrow against the equity you have built up in your home.
Since your home serves as collateral for the line of credit, you can typically secure a low interest rate. In addition, there may be a tax benefit if you use the line of credit to pay for major home improvements and renovations. In that case, you can deduct the interest you pay on your HELOC from your federal taxes.
Whether you can get a large home equity line of credit depends on the current market value of your home and the outstanding balance on your existing mortgage.
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How Large of a HELOC Can You Get?
Lenders use a tool known as the loan-to-value ratio (LTV) to determine how much credit they will extend as a HELOC. A simple LTV represents how much you currently owe on your mortgage relative to the current market value of your home.
Many lenders won’t consider your application unless you start out with an LTV lower than 80 percent. In other words, you need to have at least 20 percent equity in your home to get a HELOC – although some might allow less.
Next, lenders consider something known as the combined loan-to-value ratio (CLTV). This is the total outstanding balance on your mortgage plus the total balance on the HELOC relative to the current market value of your home. Lenders don’t want the CLTV to be greater than 80 percent to 85 percent.
Consider two examples to see how this works if the current value of your home is $100,000:
First, assume that you currently owe $40,000 on your existing mortgage. So, you currently have an LTV of 40 percent. If the lender allows you to borrow up to a maximum CLTV of 80 percent, that means your maximum home equity loan amount is $40,000. On the other hand, consider a situation where you still owe $75,000 on your mortgage and have an LTV of 75 percent. The maximum HELOC you could get would be $5,000.
Large HELOCS vs. Alternative Options
The interest rate on a HELOC is often the least expensive borrowing option you can get. Unsecured personal loans are another way you can borrow a large amount of money. The interest rates are typically much higher than those on the HELOC since there is no collateral backing the loan up.
If you have a high credit limit on your credit card, it could also be a good option for short-term borrowing needs. Although, with average annual interest rates of 20 percent to 30 percent, credit cards are not a good choice for long-term borrowing needs. The only thing more expensive than this would be to get a cash advance with interest rates that even exceed credit card rates.
In certain circumstances, you may be able to get dealer financing. If you were planning to use your HELOC to pay for a vehicle or boat, the dealership might be able to offer you better financing terms than those you would get on your HELOC. Since auto loans are also secured loans, they usually have low interest rates.
Tax Deductibility on HELOCs
As of 2018, you can only deduct the interest you pay on your HELOC on your federal taxes in a couple of circumstances. The interest is tax deductible if you use the loan proceeds to build an addition onto your home or make major home renovations. The benefit is marginal when you have a small HELOC or small home equity loan, but the tax benefit can be large when the loan or line of credit amounts are large.
HELOC Risks to Watch Out For
The major risk with a large HELOC is the risk to your home. If you borrow a large amount of money, your monthly payments will also be large, even after you amortize them over 10 to 15 years. If you are unable to make these payments, the lender will foreclose against your home to fulfill your debt obligation.
Author: Kimberly Goodwin, PhD