- A home equity line of credit allows a homeowner to have access to the value of their home in excess of the mortgage. Since this excess value technically belongs to the owner free and clear, it counts as positive net worth. However, there is no way to access this value without selling the property. A home equity line of credit allows the homeowner to access the value by way of a loan that uses the equity as collateral.
- A home equity line of credit generally has some standard features. The primary feature is the maximum line amount. Similar to the credit limit for a credit card, the maximum line is the amount at which the lender will no longer provide new money under the terms of the equity line. When people say they have a $50,000 equity line of credit, they typically mean that the maximum line is $50,000. Another standard feature of an equity line is the interest rate and payment requirement. Most equity lines require the monthly payment of at least the interest due although some lines will allow a borrower to simply add the interest due to their equity line, thus increasing the balance.
- A home owner with a home equity line of credit enjoys several benefits. Because the home equity line already exists, the borrower does not have to wait in order to access the fund by filling out an application and awaiting approval on a new loan. The home equity line is variable so if an owner pays off $5,000 but subsequently needs $3,000, the borrower can simply re-borrow the needed $3,000 without having to refinance. With a home equity line, the lender does not necessarily receive all the money up front, so if a borrower needs $10,000 today but does not need the other $40,000 until later, the borrower can save interest cost by only taking the $10,000 and thus only paying interest on $10,000 instead of the full $50,000.
- Home equity lines of credit are often confused with home equity loans. Technically, a home equity line of credit is, as its name implies, a reusable and flexible credit line which can be accessed at any time. A home equity loan, on the other hand, is a fully amortized loan in which the full amount of the loan is distributed at the beginning of the loan and then regular payments are made until the loan is fully paid off. A home equity loan has no mechanism for re-borrowing previously paid principal, nor for having a partial distribution at the beginning of the loan.
- Home equity lines often come with very easy mechanisms for access including checks and debit cards. This makes it very easy to use the line of credit on small purchases and ring up large balances without fully noticing it. In addition, the ability to re-borrow principal at any time can create a perpetual loan that is never paid off. This can be particularly troublesome for people approaching retirement.
- When choosing a home equity line of credit several things should be taken into consideration. The maximum line is one consideration. Many lenders will tell you to simply take as much as you can get because you don't have to use it if you don't want to but it is there if you need it. However, the maximum amount of the equity line is taken into account for credit score purposes so a bigger than necessary equity line may cost you higher interest payments on other lending such as car loans. The interest rate and minimum payment calculations are important considerations as well. Obviously, a lower interest rate is better. Some equity lines will require a larger minimum payment than others. Some will allow for an interest only payment while others may require a percentage of principal also be paid.
- Because home equity lines of credit are flexible by nature, they typically come with no real time frame other than a future date at which the line expires. Until that date, however, there is no real time component to the line.
