About Home Equity Credit Lines

By W D Adkins

  • Overview

    Homeowners often want to make use of the equity they have built up in their homes to pay other expenses. One option you have for doing this is a home equity credit line (HELOC). Because the money you are borrowing is secured by the home, interest rates are generally lower than other forms of consumer credit. Home equity credit lines have advantages and disadvantages, so you should understand what the costs, obligations and risks are before you commit to one.
  • Identification

    Home equity credit lines are similar to credit card accounts. You can borrow up to a specified limit, but don't have to use the entire amount available. The key difference is that a home equity line of credit is secured debt, with the home as collateral. This lowers the risk for the lender and usually means a lower interest rate. Lenders typically determine the size of a HELOC by taking a percentage of the value of the home and subtracting the balance of the mortgage. For example, if the allowed debt percentage is 80 percent, and the home is worth $150,000, the total debt allowed would be $120,000. If the mortgage balance is $80,000 the remaining $40,000 can be used as a home equity line of credit.
  • Features

    Using home equity credit lines is not complicated once they are set up. Banks provide checks or a credit card (or both) for the borrower to use. Most homeowners reserve HELOC borrowing for major expenses such as medical bills, home remolding, or to pay college expenses. Unlike a credit card, most HELOCs have a limited "draw period" of several years. Unless the plan is renewable, you may not borrow after that time. In addition, some plans call for the balance to be paid at the end of the draw period.

  • Function

    Most home equity lines of credit have variable interest rates. Typically these are tied to an index (the prime rate, for example) and equal to the index plus a stated percentage. Under federal law, there is a ceiling on any HELOC interest rate, but homeowners are advised to take the possibility of higher interest rates and monthly payments into consideration when applying for or using this type of borrowing. Some plans do have fixed interest rates or will allow you to convert all or part of the balance to a fixed rate.
  • Costs

    The process of opening home equity credit lines is similar to those for mortgages. You pay the cost for a home appraisal and application fee. You may have to pay closing costs and points (upfront fees) as well. Many plans also have transaction fees and annual maintenance fees. Most financial advisers suggest you not get a home equity loan except for major purchases or expenses, since these costs can run to several hundred dollars. Some HELOC plans require you to have an initial and/or ongoing minimum balance drawn (borrowed) on the account or set a minimum amount (usually around $500) per transaction.
  • Considerations

    Home equity credit lines carry some risks. The most important is that your home is collateral, and if you are unable to pay the principal and interest, you can lose your home. Under certain circumstances, a lender can freeze or reduce a home equity line of credit. This happened on a large scale in 2008 when home values fell dramatically. Many lenders froze HELOC accounts when the equity value in the homes dropped. Finally, you may be required to pay the entire balance if you sell the home, so take this into consideration if you don't plan to stay in the house for more than a few years.

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