November 7th, 2019 8:39 AM by Jackie A. Graves, President
What is a home equity line of credit? If you’ve been
looking for a way to get a little money out of your home without actually selling it,
you’ve probably come across this option, known as a HELOC for short
(pronounced "heelock"). Clear as mud, right? Now that you're no doubt
wondering what is a home equity line of credit going to do for me, let us
Home Equity Loan (also known as a "second mortgage"), a
HELOC allows you to borrow money using the equity in your home as
collateral. But the thing that differentiates a HELOC is that it’s like a
credit card: You can borrow on an as-needed basis, up to the loan’s limit,
over the term of the loan (usually 5 to 20 years). In fact, your lender will
actually issue you a small plastic card that looks just like a credit card, to
allow you to access your money easily.
works well for those who want to borrow money but don’t know exactly how much
they’ll need, or for people who don’t need to borrow a lump sum all at once and
will be paying for something over time —i.e. medical bills, college tuition, or
major additions to their home.
For example, let’s say you want to add an extra bedroom and
bathroom onto your house, and a contractor has given you an estimate that the
project would cost $50,000 total. You could set up a Home Equity Line of
Credit for $50,000, and pay for the materials, services, and labor over time,
as the bills come due.
the HELOC should be used for home renovations or for big, unforeseen expenses
that you don’t have the cash reserves to cover,” says Jason
van den Brand, co-founder of online mortgage platform
Lenda.com. “But it should not be used for everyday living expenses, just to
make ends meet, or if you just need a very small line of credit.”
What is a
home equity line of credit worth financially? The total you can
borrow depends on how much equity you have in your home. A lender will
usually allow you to borrow approximately 75%-85% of the home’s appraised
value, minus what you still owe on it.
it down, let’s say you have a home that’s been appraised at $100,000, and you
still owe $40,000 on it. Your friendly neighborhood bank would take 75% of your
home’s value (in this case $75,000), then subtract the $40,000 you still owe on
it, leaving $35,000. The bank would then set up a HELOC with a limit of
$35,000, which you could borrow chunks of over time.
equity isn't the only factor lenders look at. According to the Federal Reserve’s Consumer Finance
Division, “in determining your actual credit limit, the lender will
also consider your ability to repay the loan (principal and interest) by
looking at your income, debts, and other financial obligations, as well as your
convenient aspect of the HELOC is that payments can be relatively flexible.
Different lending institutions have different requirements, of course, but some
will allow you to make interest-only payments until the term of the loan is up,
when you’re required to pay off the whole thing. Others require that you pay a
percentage of the principal as you go.
are, however, some details that almost all HELOCs have in common. They are:
You pay interest only on
what you borrow. So if your limit is $25,000, but you’ve only borrowed $5,000
of that, you’ll pay interest on $5,000.
Interest rates on a HELOC
are variable, which means they go up and down depending on certain economic
factors. Some lenders offer a low “introduction” rate, which lasts for a matter
of months, but after that, the interest rates will adjust—and continue to
Your credit “revolves,”
which means that once you’ve paid off a certain amount, you can borrow that
much more again. Say for example, you’ve received a $30,000 home equity line of
credit so you can do some improvements that will add value to your home. You
borrow $10,000 to fix the roof, and you pay that back within a year. At that
point, you’ll still have a $30,000 line of credit, and you can go ahead and redo
Average interest rates for
home equity credit lines are generally lower than for other types of home
loans, because the lender’s risk is lower. After all, your home is their
collateral, and you already have a track record of how well you pay it off for
the bank to review.
may sound sweet, but all that free-flowing cash doesn't come without
risks. If you don’t pay off your HELOC under the terms you’ve agreed to,
the lender can foreclose on your
home. It doesn’t matter how much you’ve paid on your first
mortgage; a HELOC (which is considered a second mortgage) can be
lethal. So, as with every type of home loan out there,
it’s best to be cautious and do your homework.
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