Home Equity Line of Credit

How Much Should You Borrow?

If you need extra cash, a home equity line of credit may be the right instrument for you. It gives you the flexibility you need, with minimal closing costs and the option to pay interest only for the first five to 15 years. However, you must decide the amount that's appropriate to borrow.

Setting Your Limits
The HELOC limit depends on how much equity you own in your home. Let's say the house appraises at $200,000. If your first mortgage balance is $80,000, your equity is $120,000. A second loan that's secured by this equity, such as a home equity loan or a home equity line of credit, can usually have a credit limit as high as 80 or 90 percent of this equity. For our example, we'll opt for a 90 percent HELOC, which would enable you to apply for a maximum credit line of $108,000.

One very important thing to remember is that a home equity line of credit is not a traditional loan. You don't apply for a loan amount, technically speaking, but rather for a credit limit. Once the credit line has been approved, you can treat it like a credit card. Borrow the money when you need it, and replenish it when you can. In the meantime, all you need to pay is interest on the amount you borrow. You're under no obligation to borrow every last cent of that line of credit-though you can if you need to.

How To Use Your Credit
It may be best to simply apply for the maximum amount that you qualify for. This way, you have a cushion to protect you in case of emergencies. You may not need all of that money now, but it's there if you need it later. Closing costs for HELOCs are minimal. However, many states require that you pay a one-time mortgage tax at closing. The higher the credit line, the higher the tax. As a result, you may not want to opt for the maximum amount.

There also may be direct benefits to establishing a high credit line, even if you don't plan to use most of it. Credit bureaus like seeing lots of available credit that you haven't used. A largely unused HELOC may, therefore, improve your credit score.

Once you're approved for your credit line, you still don't have a license to go out and spend it all. Every dollar spent will eventually have to be repaid-with interest. Get the highest credit limit you feel comfortable with. Then be disciplined about how you use it. Your wallet will thank you later