There are some key advantages of using a HELOC. They are:
- Interest rate of around 4% (as of March 2014)
- Minimum payment of interest only (which is very powerful with the low 4% interest rate) during the draw period
- 10 year draw period
- 15 or 20 years to repay
- the first $100k of home equity debt for any purpose including education can be deducted
That is why many people use it for funding an MBA program, home renovations, car purchases, etc. Interest is low. And the monthly payment is very low during the 10 year draw period. This may be a better alternative than to paying for an MBA with a 401(k) retirement account.
To get a HELOC, you need several things:
- primary residence or vacation home with more than 20% equity
- credit score of 700 or better
- DTI under 45%
If you have all three of these things, you can get a HELOC to pay for your MBA, home renovations, or almost anything else. Don’t tell the bank you’re using it to open a business, invest in stocks, or buy real estate. For reasons I don’t understand, they don’t mind if you use it on a vacation instead of investing. But whatever….
Equity in a Primary Residence or Second Home
First of all, you will need more than 20% equity. After the housing bust, you are going to have a hard time finding a lender that will give you a LTV (loan-to-value) of 85% or higher. Right now, US Bank will do a HELOC for 85% in most states except for those with significant price declines during the bust (eg. AZ, CA, FL, MI). For those four states, the max is 80% LTV.
During the application process, you will get an appraisal. With lines less than $500k, it will likely be a drive-by or computer appraisal. The appraisal is usually free, but ask your lender to make sure. If you need a full appraisal, it is likely that the lender will make you pay for it.
Generally, your credit needs to be at least in the 700-720 range depending on the lender. If you score is below 720, you may have significant credit problems that may result in a denial such as late payments or high utilization on credit cards. If you have enough equity to pay off the credit card at closing, the bank won’t count it against your DTI as long as you’re willing to close the account. If you don’t have enough home equity to consolidate debt with high utilization, you may be denied.
DTI Under 45%
The bank wants to make sure your monthly debt payments are affordable. They are going to assume a 1% or 2% minimum payment on the HELOC maxed out. Usually it is 1%. Then the bank adds in all of your other minimum debt payment, your first mortgage, HOA fees, insurance, and property taxes. If all of that is more than 45% of your gross income, then you will be denied due to a high DTI (debt-to-income) ratio or you will need to reduce the maximum on your HELOC.
In most cases, there are no closing costs. The only exception is if you close the line within the first three years. Otherwise, there is no cost other than a possible annual fee.
It will take around 3-4 weeks to get the HELOC. There will be a signing just like with the first mortgage, but you will likely sign fewer documents. After the HELOC is opened, you will get a checkbook in order to withdraw funds from the credit line to pay for expenses such as college tuition. That’s all there is to it.