How to Know About Home Equity Line of Credit (HELOC)

What exactly is a Home Equity Line of Credit? How can it work for me? Get answers!

Difficulty: Easy

Instructions

1. HOME EQUITY LINE OF CREDIT
   
   A HELOC is a lot like a mortgage. A borrower uses home equity in property as collateral for a loan. All the rules of repayment associated with a mortgage or second mortgage also apply to a HELOC. Also, income and other qualifications associated with a mortgage (including property inspection) generally apply to a Home Equity Line of Credit. However, there are some important differences between a mortgage and a HELOC.
   
   A Home Equity Line of Credit, unlike a mortgage, does not lend in a lump sum when the credit line is issued. Once a borrower is approved for a line of credit, they may begin using that credit and continue using that credit for as much as 25 years or more. With a HELOC, only the credit used by the borrower has interest applied to it. The unused portion remains available, but not interest accrues until the money is used, if it is.

2. MAJOR ADVANTAGES OF HELOC
   
   The greatest advantage of a Home Equity Line of Credit is that the borrower is only charged for credit they use. Money is available to the borrower when needed, but unused credit does not cost the borrower interest.
   
   HELOCs are also tax friendly. They offer greater deductions than most standard loans.
   
   Establishing a HELOC in advance can provide a means of making mortgage payments should the borrower face difficult financial times. However, the borrower should be aware that they are likely transferring debt from a lower interest rate mortgage to a high interest rate equity line. Also, this practice may be in violation of certain HELOCs.

3. DISADVANTAGES
   
   Home Equity Lines of Credit can be expensive. Most have Adjustable Interest Rates, starting with agreeable interest terms that increase over time. Because a home or property is used as collateral on the HELOC, the borrower is essentially agreeing to terms that resemble those of a high risk mortgage. There are also extend lending and maintenance fees, and closing costs.
   
   Because the interest on a HELOC is not fixed, the ballooning cost of the credit line may jeopardize the borrower's ownership. Defaulting on a HELOC will have the same result as defaulting on a first or second mortgage: foreclosure.
   
   Home equity lines of credit, once established, are easily access. So, like a credit card, borrowers often find expenses easier to justify. Use of credit may be unwise at times and endanger the borrower's ability to repay.

4. HOW MUCH CAN BE BORROWED?
   
   A percentage of the borrower's equity value will be determined by the lender according to many factors, including the borrower's credit history and FICO score. Percentages assigned range anywhere from below 10% to 85% and is decided by the lending agency. A common percentage issued is 50%. The borrower may wish to shop around for lenders willing to assign a higher percentage.
   
   That percentage is applied to the borrower's total equity in the home. That is the value of the home minus the total mortgage value (and/or second mortgage) and any outstanding loans or leans on the property title. So, if the value of a property is $200,000, and the outstanding mortgage balance is $120,000, the borrower's home equity is $80,000. Assuming the borrower has been approved for a home equity line of credit valuing 50% of their equity, the line of credit would be $40,000.
   
   Many lenders reserve the right to adjust the total line of credit available to a borrower based on the fluctuating value of a home. These lenders may review tax appraisals or conduct their own appraisals periodically.

5. HOW IS A HELOC REPAID?
   
   Repayment terms for Home Equity Lines of Credit vary dramatically from case to case. Some do not require immediate repayment, while others do. Some allow for principle only repayment periods, while other require interest only repayment periods. Almost all require immediate repayment of an outstanding balance should the the property's title transfer ownership for any reason, including foreclosure.
   
   Check the exact terms of each offer you receive to know what sort of repayment will be required of you.

Tips & Warnings

• Attempt negotiating terms. No matter what your lender tells you, there really are no standard terms for Home Equity Lines of Credit.
• Read the terms of your HELOC carefully before signing. Make sure you understand what you are agreeing too.
• If using your HELOC for emergency situations, get it in place before the emergency strikes.
• REMEMBER: These are essentially high interest loans with your home on the line. Default WILL result in foreclosure. Borrow Wisely.

Resources

• Where do Foreclosure Sale Proceeds Go?
• Understand Second Mortgages
• Important Facts about Reverse Mortgages
• How to Find Foreclosure Property Sales in Your Area FREE
• More Articles by Kate Downs

[Melanierose]

on 7/21/2008 Very helpful thank you!

[luv2blog]

on 7/19/2008 Thanks for the info.

[LilacGirl]

on 7/18/2008 This is such a good article, and it sounds like it would work out great.

[Hapworth]

on 7/18/2008 I did this once and it was great. The money was there when you needed it. Good article.

[oneloved]

on 7/18/2008 Very informative! People need to know what they're getting into.