A Home Equity Line of Credit (HELOC) is a financial product that allows homeowners to borrow against the equity of their home. Equity refers to the difference between the current market value of the home and the remaining balance on the mortgage. Essentially, a HELOC is a revolving line of credit, kind of how a credit card works, which can be used by homeowners for a variety of purposes.
You will need to have an understanding of what a HELOC is as a real estate agent so that you can better understand the financial situation of your seller or, if asked by a homeowner about renovations they intend to make using their HELOC.
How HELOCs Work
A HELOC operates as a line of credit, with a pre-established borrowing limit based on the equity in the borrower’s home.
For example, if a homeowner owes $300,000 on their mortgage and their home appraises at $500,000, they may have up to $200,000 in potential equity.
It’s unlikely your client will have access to the entire $200,000. Typically, lenders and financial institutions will offer a HELOC for 75-85% of the home’s appraised value minus the remaining mortgage.
Here are some things to know about a HELOC:
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- Getting the money: Your client’s home will undergo an appraisal at which the lender will offer you a credit amount. Your client can then access the funds like a checking or saving account.
- Pay Back: At first your client may only need to make interest only payments during the draw period, but once that period ends, the repayment period begins. Each of these periods can be 5-10 years.
- Interest Rates: While your clients home could potentially have a fixed mortgage interest rate, the HELOC is an adjustable interest rate. Meaning, it’s tied to the benchmark like prime rate which can fluctuate over time. Eg. Your client’s equity is $100,000. They are offered a HELOC of $75,000 at the prime rate of 5%. Let’s say in five years, the prime rate increases to 6.6%, your client’s monthly payment could increase if they are in the repayment period.
Let’s now discuss the drawback of a HELOC that you as a real estate agent must understand if you intend to counsel remodeling for the intent to sell using a HELOC.
Drawbacks of a HELOC
While HELOCs offer benefits, they come with certain risks and disadvantages:
- Variable Interest Rates: As discussed above, monthly payments can fluctuate based on market conditions. This can make it difficult for homeowners to predict their future payments and manage their budgets accordingly.
- Risk of Foreclosure: Because a HELOC is secured against the home, if the borrower fails to repay the loan, the lender has the right to foreclose on the property. This makes HELOCs riskier than unsecured loans like credit cards or personal loans.
- Fees: Some lenders charge annual fees, origination fees and/or closing costs for HELOCs.
When answering questions about HELOCs as a real estate agent, be sure to stay in your lane, Advise your client to seek advice from a licensed professional. While you may think of using a HELOC to help with property condition prior to listing a property, it’s important to discuss the downside if you can’t get the price required in a purchase to pay off both the remainder of the mortgage loan and the HELOC. Tread carefully, as the lasting implication of advising too much risk could leave an adverse legacy on your client’s finances.
