What is A Home Equity Line of Credit

In simple terms, a home equity line of credit, also referred to as an HELOC, is a loan whereby the lender agrees a maximum amount would be lent within an agreed term.  In this case, collateral for the loan would be equity built up in the home.  Using the available equity, the homeowner could complete home improvement projects, send a child off to college, purchase a new vehicle, pay off bills, and much more.  When an equity line of credit is lent by a reputable lender and the loan is managed properly, it is a great deal but when mismanaged it can be disastrous, which is evide

In simple terms, a home equity line of credit, also referred to as an HELOC, is a loan whereby the lender agrees a maximum amount would be lent within an agreed term.  In this case, collateral for the loan would be equity built up in the home.  Using the available equity, the homeowner could complete home improvement projects, send a child off to college, purchase a new vehicle, pay off bills, and much more.  When an equity line of credit is lent by a reputable lender and the loan is managed properly, it is a great deal but when mismanaged it can be disastrous, which is evident in its involvement of the subprime mortgage crisis.

Remember, a home equity line of credit is not the same as a standard home equity loan.  The difference is that with a conventional loan, you would be provided with the entire amount of the loan to use for whatever purpose it was borrowed.  On the other hand, the equity line of credit loan is literally a line of credit, much like a credit limit set on a credit card.  When you want to use some of the money, you would take it out of the established account, which would decrease the amount available.

Now, with a home equity line of credit, lenders would set up what is known as a “draw period.”  This timeframe, which is anywhere from five to 25 years is the time in which you could pull money from the account to use.  In addition, some lenders will set up a loan of this type with minimum monthly payments, with the payments typically being interest only.  In most cases you would be permitted to make a payment in any dollar amount but only if it were more than the agreed upon payment.  However, you want to read the terms of the loan carefully in that often there is a hefty penalty for paying the loan off earlier than scheduled.

With a home equity line of credit, you would also find that at the end of the draw period, regardless of its duration, the full principal amount would be due.  Depending on how the loan was set up, this could be in one lump sum or balloon payment, or based on an established amortization schedule.  In other words, for a period of this type of loan, the payments being made would only go toward the interest on the loan with the actual principle amount borrowed against the equity in your home would be paid at the end of the loan.

You will also find another difference between an equity line of credit and standard loan.  With the equity loan, interest would be variable.  Usually, the amount of interest charged would be based on an index, perhaps the prime rate.  With interest being variable, it means there could be some fluctuation with market movement due to various economic changes.  It is essential when looking for the best home equity line of credit that you understand that the way in which the margin, which is the difference between prime rate and interest you would pay, is calculated varies from one lender to another.

Starting in the early 2000s, the home equity line of credit gained popularity.  Although this was due to a number of factors, the primary reason was that interest paid was usually deductible according to current state and federal income tax lasts.  Because of this, the cost associated with borrowing money against the home’s equity is less expensive and the tax incentive is much better than with a conventional type of loan.

Remember, a home equity line of credit is a flexible solution, another reason this type of borrowing has become so popular.  Not only are the terms of the loan flexible, but also the repayment schedule.  In fact, most lenders would allow you to choose the schedule that would work best based on your situation.  This means instead of being offered a cookie cutter solution, you have a loan that is somewhat customized for you.

As you can see, a home equity line of credit comes with a number of benefits but along with the positive, there are some potential pitfalls.  The most important thing to remember is that with the collateral for this type of loan being your physical home, if for some reason the loan were defaulted on, there would be risk of the home going into foreclosure and being lost.  Therefore, when taking out a line of credit, remember the critical nature of making all payments according to schedule.

To protect you as the homeowner, you would discover that reputable lenders would generally require you to maintain a certain level of equity in the home.  That way, if the loan were defaulted on, you would have a buffer whereby the home would be protected.  Let us say that you had paid the payments on time each month but then became ill and for several months could not work.  Having some of the equity left untouched, payments due on the home equity line of credit during those months would be covered by the equity left.  As you can see, this type of loan offers tremendous benefit but just as with any loan, you need to work with a qualified lender to lock into the best rates and terms.