How to Understand Home Equity Line of Credit

A home increasing in value.

Wondering how a home equity line of credit works and whether it could help improve your financial picture? This type of loan was very popular for a brief period during the housing bubble, and while they are less common during economic downturns or slow real estate markets, as of 2009, they do still exist.
Before deciding if it's right for your situation, understand home equity line of credit and how it operates.

Instructions

Understanding a Home Equity Line of Credit

1. Learn what the term equity means---it refers to the difference between what is owed on a property and the property's appraised value. Thus, a house with a mortgage of $50,000 that appraises for $85,000 has a net equity of $35,000.

2. Discover how a line of credit works. Depending on the terms of the loan, a home equity line of credit may cover all of the net equity in the home or just a percentage. For example, if the bank will make a loan based on 50 percent of the net equity, someone with $35,000 equity would be able to apply for a line of credit of $17,500.

3. Find out how to qualify. The borrowers must be owners of the property and have the signed permission of any other property owners before proceeding. Specific qualifying factors will depend on the bank or loan program, but good credit, low debt-to-income ratio and good employment or sufficient income are all important when applying for a home equity line of credit.

4. Ask how you will be able to use the home equity line of credit once the loan settles. Generally, you can access the money through bank transfers to your checking account, checks and sometimes even a debit card that takes the money from your home equity line of credit account.

5. Read the repayment terms carefully. What is the interest rate? What amount of money will be due each month once you start using the credit line? Usually, home equity lines of credit are on a revolving basis, and you can pay just interest on borrowed funds, or interest and principal. As you pay off borrowed funds, that amount of credit is opened back up to you. The interest is usually an adjustable rate that fluctuates with the market, but often you can lock in portions of what has been borrowed to avoid rate increases.

Tips & Warnings

• Use a home equity line of credit for improving your home or buying other properties or land. These are long-term appreciating assets and will help you preserve your wealth.

• Avoid worsening your financial situation by poor use of the home equity line of credit. Don't squander your equity on consumer goods, vacations and daily living expenses, as paying it back will be difficult.