HELOC rates hit their lowest levels since November. Should you consider a home equity line of credit?

As home prices rise, tappable home equity — the amount of equity available for homeowners to access while retaining at least 20% equity in their home — has hit a record high, according to the latest data from analytics firm Black Knight. Now, the average mortgage holder’s equity stake is roughly $178,000, the report estimates. This is leading some homeowners to wonder whether they should take out a home equity line of credit. Here’s what you need to know before you do.

What are the latest HELOC rates?

Some HELOC rates hit their lowest level since November for the week ending January 9th, with an average interest rate of 5.89% for a 20-year repayment period. For loans with a 10-year repayment period, the rate was 5.52%, according to the latest HELOC rate data from Bankrate. To be sure, many people will be offered higher rates — especially those with lower credit scores — but others can land a lower one: You can see the rates you might qualify for here.

What is a HELOC and how does a HELOC work?

A home equity line of credit, colloquially known as a HELOC, is a type of loan borrowed against the available equity in one’s home, in which the lender provides a revolving line of credit for homeowners to use.  Because HELOCs generally have variable interest rates, the amount you owe during the repayment period will vary depending on baseline interest rates and how they’re trending. 

These types of loans tend to work well for those who don’t need a lump sum of money all at once (if that’s your situation, a home equity loan might be better; you can see the home equity loan rates you may qualify for here) and who might need more flexible repayment terms. “A home equity line of credit offers the lowest interest rate and the most flexibility, both in terms of the ability to borrow the money as needed instead of all at once, and flexibility in repayment terms during the first 10 years,” says Greg McBride, chief financial analyst at Bankrate. Experts say some of the best uses for a HELOC are for a home improvement project, to pay medical expenses or to consolidate high-interest debt.

HELOCs typically contain draw periods during which the borrower is allowed to withdraw from their line of credit. During the draw period, which is usually 10 years, the borrower is typically only required to pay the interest of the loan; after the draw period is over, the borrower can no longer use the line of credit and must repay the balance of the loan, including both principal and interest. This repayment period typically lasts 20 years. Note that your HELOC may contain a conversion clause, which allows a loan to switch from an adjustable rate to a fixed-interest rate for an additional charge during a specified time during the loan. 

The key warning with a HELOC is that you’re using your home as collateral, so if you fall into financial trouble and can’t make the payments, your home may be at risk, says Bobbi Rebell, a certified financial planner and personal finance expert at Tally. Another thing to keep in mind are HELOC fees —  the upfront costs including an application fee, title search, appraisal and more can cost hundreds of dollars, so if you’re looking for a small loan, there might be a better solution out there.

How much money can I borrow? 

You’ll need equity in your home to get a HELOC, and lenders typically allow borrowers to withdraw up to about 85% of the value of their home.

What factors determine how much you’ll pay for a HELOC?

You need things like a good credit score (the best rates typically go to people with scores of 740 or higher, but you can qualify for a HELOC with a lower score); a reasonable debt-to-income ratio (the lower the better, with 43% being about the highest acceptable number); and an acceptable loan-to-value ratio. To calculate the LTV ratio, divide the amount borrowed by the appraised value of the property. If a home is appraised at $400,000 and your mortgage balance is $140,000, your LTV is 35%. 

“A credit score of 740 will typically get you the best HELOC rates although some lenders set the bar even higher. Although some lenders allow you to borrow up to 85% of your home’s value, if you borrow 70% or less, you’re likely to get a better rate,” says Denny Ceizyk, senior staff writer at LendingTree. Adds McBride: “Keeping your total borrowing, including both your first mortgage and the line of credit you’re seeking, at no more than 80% of the home’s value is a common prerequisite for the best rates,” he says. 

According to Holden Lewis, home and mortgage expert at NerdWallet, the best HELOC rates go to customers with the following characteristics: “Their monthly HELOC payment is automatically debited from another account with the same bank, they have a high credit score (usually 740 or higher) and the credit line is for 70% or less of the home’s appraised value,” says Lewis.

How to get a HELOC

McBride recommends comparison shopping among lenders to find the best rates. Get quotes from 3-5 different lenders, and compare not just rates but also terms. Ask about discounts too: Ceizyk says that you might qualify for extra discounts if you tie your monthly payment to your checking or savings account.