What Collateral Do You Use for Home Equity Lines of Credit?
Home equity lines of credit (HELOCs) are a popular way for people to use the equity in their home to have access to money. HELOCs are loans and therefore have some item to back them up in the form of collateral. In this case, your home's equity is what the bank will use to guarantee the line of credit.
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Definition
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A home equity line of credit is a revolving line of credit that the homeowner has access to at any time. It is similar to a credit card in that a set amount of money is available and a portion, or all of it, can be taken out at the homeowner's discretion. Once the money is accessed, interest starts to accrue and borrowers must make at least minimum monthly payments.
Collateral
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When you purchase a home, you agree to pay the lender back through a mortgage. As you pay on the mortgage, the gap between the value of the home and what is owed on the mortgage widens. This difference is called equity. When you apply for a HELOC, your home's equity value is the collateral. Once you have the HELOC, both the primary mortgage and the HELOC will use the value of the home as collateral.
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Function
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The function of a HELOC is to provide a set amount of money for whatever purpose the homeowner needs, such as renovations to the home, a vacation or several projects spaced out throughout the life of the HELOC. A HELOC is different from a home equity loan. The home equity loan is a set amount given to the homeowner that he must pay back via a structured loan agreement. The HELOC is not structured and once the money is repaid, the homeowner can borrow it again.
Considerations
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As the HELOC is tied to the value of your home, you should have the home appraised prior to applying for the line of credit. You will want get the best value for your home, so any small landscaping or repair jobs that you can do may raise the value. Repairs may include fixing loose or broken tiling and refreshing some rooms with new paint or wallpaper.
Warning
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As the HELOC is connected to the home similarly to the mortgage, if you default on the loan, the bank has the right to foreclose on the home. The house must be sold and the first mortgage paid off before the secondary lender will see any money. Defaulting and late payments will lower your credit score, as well.
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References
- Photo Credit house image by qadro from Fotolia.com
