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HELOC (Home Equity Lines of Credit) | What You Should Know
One of the most powerful finance options available to homeowners in the UK is the HELOC, or Home Equity Line of Credit.
A product that releases equity in your home in a flexible and manageable way, HELOCs have been common in the US for decades, but are only recently seeing popularity in the UK, where forward-thinking homeowners are now using this tool to utilise the money invested in their home to finance a range of lifestyle purchases.
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Table of Contents
A Condensed History of Home Equity Finance
What is a HELOC?
How Much Can You Borrow?
6 Uses of a HELOC
Limitations of a HELOC
HELOC Draw and Repayment Structure
The Cost of a HELOC
HELOC Eligibility
How to Apply
A Condensed History of Home Equity Finance
Prior to the 1990s, UK homeowners had very few options for releasing equity in their homes, with only a rigid set of remortgage options available, while other countries, notably the US, Canada and Australia, developed new and innovative ways of approaching home finance.
In the years leading to the early 2000s, UK lenders began to add some of these more flexible mortgage products to their portfolios, one of which was the offset mortgage, which links a savings account to a mortgage to take advantage of saved capital to reduce the interest on the mortgage.
Cautiousness regarding regulation and consumer safety has kept the UK somewhat behind in the area of home equity finance, with the Financial Conduct Authority (FCA) keen to ensure that any product offered to UK residents has been thoroughly evaluated.
This has an advantage in today’s marketplace, however, as the products that are available to UK borrowers do benefit from stringent regulations that ensure responsible lending and protect consumers from financial risk.
What is a HELOC?
HELOC stands for Home Equity Line of Credit, and is a secured line of credit that is provided using your home equity as collateral.
Understanding Equity in the Home
The ‘Home Equity’ part refers to the investment you have made in your home.
If the mortgage is all paid off, then the equity you have in your property is 100% - that is to say, you own it completely.
Homes with an outstanding mortgage will have equity in them equal to the difference between the mortgage balance and the home value.
Homes bought under shared ownership will have part equity equal to your share, minus any outstanding mortgage.
Examples of Home Equity Calculations
2 - A Shared-Ownership Flat
3 - A Home with Additional Home Equity Loan
The equity in your home represents the amount of capital you have invested in the property - it is this that is used to secure a HELOC.
Understanding Lines of Credit
Once it is set up, a line of credit is a flexible loan facility that you can dip in and out of as you need, drawing from it and paying it back at your convenience.
For example, if you had a £100,000 line of credit and bought a car for £45,000, you could simply pay for it with the line of credit, leaving you with a remaining balance of £55,000 for use.
Unlike a loan, however, where the capital is in your bank account ready for you to use, the funds remain with the credit provider until you need to use them.
This flexibility is one of the main advantages of a line of credit over a loan. You will have likely experienced lines of credit before in the form of credit cards and bank account overdrafts - both these facilities are lines of credit that operate in a nearly identical way to a HELOC.
How Much Can You Borrow?
HELOCs are available for up to 85% loan-to-value (LTV), which means they can offer a credit limit as much as 85% of the entire home equity.
Where other debt already exists on the property, this will limit the HELOC accordingly.
HELOC Limit Examples
Reusing the figures from the examples provided earlier, the available HELOC credit limits at 85% LTV would be as follows:
Example 1 (£450,000 home with 29% equity)
Example 2 (£320,000 shared ownership flat with 31% equity)
Example 3 (£600,000 home with 52% remaining equity)
6 Uses of a HELOC
There are very few limitations on the use of a HELOC, making them a flexible option for any purpose.
Most homeowners, however, tend to use the equity in their home to make similarly significant purchases.
These include:
Home renovations
Using the equity in your home to improve the property and increase its market value is a common use of home equity finance.
A HELOC is particularly useful in this respect as the true cost of renovations is often difficult to estimate and homeowners using more traditional home equity finance, such as a remortgage, find that they either overestimate the cost, leaving them paying unwarranted interest on an inflated loan, or that they don’t have enough to complete the renovations and are left seeking funding from other sources.
HELOC finance provides the perfect flexibility to make ongoing home improvements and repairs as they become necessary.
Cars and other major purchases
Cars, caravans, and mobile homes represent a significant outgoing that often requires financing. Though there are multiple good finance options available for buying a vehicle, the equity in a home can mean that rates are more competitive with a HELOC and long-term savings are available.
Holidays
With the mortgage paid off and significant equity in the home, many homeowners look to a holiday as a reward for all those years of work and struggle! With its flexible ‘dip in and out’ aspect, a HELOC is a perfect financial partner to an extended holiday, offering enough purchasing power to really enjoy the trip of a lifetime without worrying.
Supporting family study
Whether we like it or not, the costs of being a student in the UK are rising. Sadly, the financial support provided by a student loan barely covers the cost of university fees and rent, leaving most young people struggling to work alongside full-time study.
A HELOC releases the money tied up in your home in an adaptable way that is perfectly suited to provide the needed level of support to those family members in education.
Debt consolidation
HELOCs offer a way out of other debts with high interest rates with which you may be struggling.
The secured nature of a HELOC means the rate is typically lower than you may already be paying on credit cards and personal loans, making it a financially sensible option for larger debt consolidation.
Realising lifetime dreams
Home equity often represents the lion’s share of the money you have earned for decades, meaning there’s a sizeable amount of cash that can be realised through the use of a HELOC.
For many it represents the amount that allows you to realise lifelong dreams, whether that’s the perfect home cinema, a sailing trip to see whales, time without financial concerns to write that novel, or building your own home brewery.
The freedom presented by a HELOC provides you with the means to bring to reality the hopes you have harboured for years.
Limitations of a HELOC
There are a few things that you cannot use the HELOC finance for, which include:
- Illegal activities - All loans in the UK are subject to regulations which means they cannot be used for illegal activities, such as funding terrorism or money laundering.
- Business use - A HELOC is a personal finance product that cannot be used to start or support a business.
- Gambling - High risk investment and personal gambling is prohibited with a HELOC as part of the FCA’s commitment to responsible lending.
- Deposits on additional properties - A HELOC cannot be used to help purchase another home.
HELOC Draw and Repayment Structure
While HELOCs are extremely flexible, they do have a limitation on their timing. This is called the draw period and is typically a five year term.
During the draw period, you can continue to access the funds on the HELOC as described in this article, providing you with the means to use the credit as you need. Repayments are also flexible during this time, and though there are minimum monthly payments to be made, you can choose to repay a larger amount to limit (or eliminate) the interest accrued.
With the majority of HELOCs, you are able to make overpayments during both the draw and repayment periods with no additional fees, allowing you to clear the loan at any time if you have the funds available.
Depending on your HELOC arrangement, your draw period may be shorter or longer than the standard five years.
The Cost of a HELOC
There are two financial costs to a Home Equity Line of Credit: the product fee, and ongoing interest.
The product fee is a one-off fee, either a set amount or a percentage-based fee, which can either be paid in advance or added to the balance of the HELOC. Note that if it is added to the balance, it will accrue interest.
The interest rate with a HELOC is usually a variable rate, which means that it will grow and shrink in line with the Bank of England base rate. It is important that you consider the possibility of the HELOC interest rate increasing during its lifetime as this can significantly affect your monthly repayments.
As a HELOC is a secured line of credit, the interest rates will typically be far more competitive than comparable unsecured rates, such as those for personal loans, credit cards, or bank overdrafts. This makes a HELOC a cost-effective solution for many homeowners looking to fund expenditures.
The secured nature of the HELOC also means your home is at risk if you fail to make repayments. Should you fall into significant arrears, the lender will exercise their right to repossess your property to recoup their losses.
HELOC Eligibility
In order to be eligible for a HELOC in the UK, you must be a UK homeowner with equity in your property. Like most home equity finance, a HELOC is considered second charge debt on the property, meaning it is secondary to the senior debt such as the primary mortgage.
For this reason, HELOC providers have to consider the extra risk implication if other finance is secured against the property. Homeowners with a 100% equity share in their property are significantly lower risk and will consequently benefit from improved rates.
Lenders of home equity finance, including HELOCs, will only lend to a maximum total of 85% LTV on the property as a whole and any existing debt will limit the credit available through the HELOC. This is seen in detail in the examples provided in the Understanding a HELOC section above. In some cases, approval must be given by the holders of any senior debt before a HELOC can be applied.
Lenders will also fully assess your creditworthiness to be assured you can repay the line of credit facility. This will involve evaluating your credit history, your income, and your current debt-to-income ratio.
How to Apply
HELOCs are a relatively new product in the UK with only a few select providers offering this flexible option for homeowners.
Clifton Private Finance have a well-established position in the home equity finance marketplace and are perfectly placed to help you obtain a HELOC with the best terms to suit you.
If you are interested in a HELOC or wish to discuss your options for releasing the equity locked in your home, contact the specialist team at Clifton Private Finance today.
