Health care expenses generally rise as we age and need more care. Sometimes, health conditions, like decreasing mobility, are incremental and we can plan for them. Sometimes, we have an accident or another sudden change in our health that requires immediate changes in our care, our homes—and our budgets. If you own your own home and can’t afford the care you need with what’s in the bank, a HELOC is one financial product that can help.
What is a HELOC?
A Home Equity Line of Credit, known as a HELOC, is, as its name implies, a line of revolving credit. A lender will extend a certain amount of credit using your house as collateral. That is, the amount of credit available will depend largely on the equity you’ve built up in your home. Although a HELOC offers credit similarly to a credit card—you have a credit limit and you pay interest on the amount you’ve borrowed—there are several important differences that make HELOCs particularly useful for certain financial needs, like home improvements or in-home care.
Unlike a credit card, a HELOC has a “draw period,” a certain amount of time during which you can use however much of the available credit as you need to pay for anything. (There are no restrictions on how the money is used.) During the draw period you pay only the interest on the amount you’ve borrowed, not any of the principal.
After the draw period, which is usually five to 10 years, you are responsible for repaying the loan principal. The repayment period can range from 10 to 20 years, or you may be responsible for the whole amount as soon as repayment begins, depending on the lender and your HELOC agreement. In other words, during the draw period, there are relatively minimal payments, as you are only paying the interest on the money you’re using, whereas once the repayment period begins, the payments are much higher, as you are paying back the principal, i.e., however much of the credit you actually used.
When to consider a HELOC
Like most financial products, a HELOC isn’t right for every situation. If you’re in need of ongoing care, a HELOC is likely not your best option. If you need an infusion of cash to pay for home modifications or health care for a limited period of time, a HELOC can be a good solution. (Read about other financial products that can help pay for ongoing care in a previous blog post.)
For example, Margaret is a widowed 79-year-old retired school teacher living in Portland, Oregon. Unfortunately, while she was going up her front steps last week, she fell, breaking her hip. Her doctors have explained that she will recover some of her mobility, but she will need to stay in a rehabilitation center for two months. And, in order to stay in the beloved home where she raised her two children, Margaret will need to make some accessibility improvements to accommodate her now limited mobility.
She receives $1,600 from her teacher's pension and an additional $1,400 from Social Security. Up until now, Margaret has had a surplus of about $1,100 every month after paying for utilities, groceries, insurance, and medication. That normally comfortable surplus will not begin to cover the cost of her rehabilitation, which will be around $12,000 a month because Medicare denied her coverage due to her initial hospital stay not being at a Medicare-approved hospital (this is just an example - please check your individual coverage for rules). In addition, the home modifications Margaret needs will cost about another $15,000. Unfortunately, she does not have enough savings she can tap into to cover these new expenses.
However, Margaret does own her home, and she has fully paid off her mortgage. The current market value of Margaret’s house is around $550,000, giving her significant home equity, in addition to her limited but comfortable monthly income. Given her income and home equity, she would likely be eligible for a HELOC of about $100,000, which would be more than enough to cover her rehabilitation and any modifications she needs to make around her home.
Margaret can obtain a 30-year HELOC with a 10-year draw period and a 20-year repayment period. For using $40,000 of credit, her monthly payments would be under $450 per month, an amount she can afford given her current income and expenses. However, it is important to note that Margaret’s payments might increase since her HELOC has a variable interest rate.
How much cash can a HELOC provide?
With a HELOC, you can usually access 75% - 80% of the home’s value, reduced by the existing mortgage, i.e., 75% - 80% of the equity you have in the home, not how much the property would sell for. The cash is available through special checks or a credit card.
Here’s what lenders take in to account when determining how much credit to offer:
- Your home equity—how much of your home you own and how much that is currently worth—must be at least 15%
- Your credit rating (600 or above)
- Your debt-to-income ratio (40% or less)
As we saw with Margaret, you still have a debt-to-income ratio when you’re retired, which is measured by adding any pension income, Social Security payments, and income from retirement accounts, and dividing that total by your total debt.
HELOCs usually have much lower interest rates than personal loans or credit cards, but, because the interest rates are variable and tied to the prime rate, they can go up, sometimes significantly. For example, the prime rate on August 14, 2023, was 8.5%, but in the last 52 weeks, the low was 5.5%. An 8.5% rate on Margaret’s $40,000 line would add $100 to a monthly payment that had been calculated at a 5.5% rate. Depending on the lender, you may be able to convert a variable rate to a fixed rate.
Unlike a credit card, a HELOC usually cannot be increased, even if your home value rises. However, a HELOC can be modified or the lender can extend a new, second line of credit.
Is a HELOC right for you?
If a HELOC sounds like it might be the right financial product for your circumstances, there are a few factors it’s important to keep in mind before applying for one.
- You run the risk of foreclosure: As with most loans, if you cannot pay back the HELOC, you risk defaulting on it, which can result in foreclosure. Foreclosure means that you lose the property when the lender sells it in exchange for the loan you cannot repay. You may still end up with some cash from the sale, depending on how much the property sells for, and how much you owed the lender. However, you still lose any ownership of your home.
- Unexpected changes might freeze access to cash: If your home’s value decreases significantly, say more than 10%, during the draw period, the lender may not let you use further credit. Similarly, if your financial circumstances change in a way that suggests you may not be able to make the monthly interest payments or pay back the loan, the lender may freeze the credit line. Either of these circumstances will result in your not having access to cash that you thought you would.
- Monthly interest payments may rise significantly: Finally, like Margaret’s HELOC, most HELOCs have a variable interest rate, tied to the prime rate. That means that the interest rate may go down—but it can also go up, increasing the monthly interest payments unexpectedly.
HELOCs don’t have as many fees as more complex financial products like reverse mortgages, but you should be sure you know what fees will be included if you apply for one. Here’s a list of common HELOC fees.
Determining which financial product is right for your particular situation can be confusing and there are a lot of providers whose offers may vary significantly in how much cash you’ll have access to and how much you’ll pay in fees. We’re here to help you understand your options. You can read about other financial products that can help pay for care you or a loved one needs, or you can speak with one of our concierges directly. Give us a call or text us at 919-230-2599.