Homeowners looking for a loan like to use home equity lines of credit (HELOC) thanks to their relatively low interest rates. The money obtained therein can be used for everything from home improvements to education costs.
There is a limit on how much money you can borrow using a home equity line of credit. Here’s what you need to know about HELOCs and calculating your borrowing limit.
What Is a Home Equity Line of Credit?
A home equity line of credit lets you borrow money against the equity you have in a house. It’s a kind of second mortgage that taps into the value of a property that you own.
HELOCs are often compared to credit cards. That’s because borrowers have their credit replenished as they go about repaying what they’ve already borrowed, much like you would with a credit card. The main difference with a HELOC is that your equity in a house is what determines how much money is available to you.
Home equity lines of credit are not to be confused with home equity loans. A home equity loan gets you a lump sum that you pay interest on over time. HELOCs, on the other hand, let you borrow money as and when you need, within a certain limit.
Data Required to Calculate Home Equity Line of Credit Borrow Limit
There are a couple of different data points you need before you can calculate your home equity line of credit borrowing limit. The first data point is the equity that you have in your home.
Home equity is the difference between the appraised value of your house and the amount that you owe in mortgage payments. It represents how much of your property you actually currently own, while you’re paying in installments to acquire the rest.
Another piece of information that you need is the loan to value (LTV) ratio. You can calculate the LTV ratio by dividing the loan amount by the value of the house you’re purchasing. So if you buy a house worth $100,000 and loan $80,000, your loan-to-value ratio is 80%.
Lenders use the LTV ratio as a measure for how much risk they’re taking on in lending money to a particular party. The higher the ratio is, the more money you have had to borrow. An LTV ratio of 80% is considered a good starting point for being able to obtain a home equity loan.
Calculating Your Borrow Limit
Now let’s use an example to see how you can calculate the amount that you can borrow with a home equity line of credit.
Let’s assume a few values about a hypothetical property you own.
- Appraised value = $300,000
- LTV ratio = 80%
- Outstanding loan = $120,000
Given these figures, the maximum debt that you secure on the property is 80% of its appraised value.
80% of $300,000 = $240,000
The line of credit amount is the difference between the maximum debt and the current outstanding loan amount.
Line of credit = $240,000 – $120,000 = $120,000
So $120,000 is the credit line that is available to you. This does not, however, mean that a lender will sanction a loan for that entire amount. In most cases, borrowers receive a line of credit equaling about 75% to 90% of the amount.
How to Get a Good Interest Rate on a HELOC
There are certain factors that banks use to determine whether you qualify for a home equity line of credit and what the interest rate is. The following are some tips for getting a good rate on your home equity line of credit.
Increase Your Equity in the Property
A home equity line of credit is extended based on the amount of equity you have in a home. It stands to reason that increasing your share of equity will lead to lenders offering you better rates. You can build your equity in a house by reducing your mortgage debt and increasing the value of the property through home improvements.
A Healthy Credit Score
As with most other loans, your ability to get a HELOC and get it at a good rate depends on your credit score. Make sure to check your credit reports before applying for a HELOC so you know if there are any errors. Taking on new debt right before applying for a HELOC can also lead to a higher interest rate.
Choose a Lender with Good Rates
If you take your time comparing the interest rates offered on HELOCs by different lenders, you will find that there can be a large degree of variance.
Start your search at your current bank or mortgage lender. These institutions are likely to give you a good deal simply because you’re already a customer. But also make sure to compare those rates with what you’re able to get from other national banks, online lenders, and private lenders.
Real estate agents in your area can be a helpful resource while shopping around for a HELOC lender. Clever Partner Agents come with many years of experience in their local real estate market and are familiar with all of the different financing options available to buyers. Enter your zip code on this page to find an agent near you.