Home Equity Line of Credit Information

By Barb Nefer

  • Overview

    Home Equity Line of Credit Information
    A home equity line of credit is a handy way for home owners to gain access to money for anything from home improvements to vacations. Its repayment terms are flexible and it may even have tax advantages. However, because it uses a person's home as collateral, it can result in foreclosure in the case of default. Before opening a home equity line of credit, you should know both the pros and cons.
  • Features

    A home equity loan, or HELOC, is a revolving line of credit that taps into the equity a homeowner has built up in his dwelling. It has a variable interest rate and, like a credit card, can be tapped into as needed. There are two important differences between a HELOC and a home equity loan. Both use the equity in a house as their collateral, but a home equity loan is for a specified amount that is given to the borrower in a lump sum and it generally has a fixed interest rate. Terms for a HELOC can vary greatly among lenders, so the Federal Reserve Board recommends that consumers shop around to find the lender with the most favorable terms. Often, the interest that is paid on a home equity line of credit is deductible under federal income tax laws. It may also be deductible in many states. This depends on specific circumstances, so borrowers should check with a tax professional to find out if these benefits will apply to them.
  • Purpose

    A HELOC may be used for a specific purpose, or it may be opened to give a homeowner a ready source of funds if they are ever needed. The borrow is given a specified credit limit and it can be accessed at her convenience and used for any purpose she chooses. This goes on for a particular "draw period," which usually runs from 5 to 25 years. Although a HELOC can be used for anything that the borrower chooses, from paying for college tuition or medical bills to taking a dream vacation, the Federal Reserve Board recommends being cautious in its use. Because the lender's home is at stake and can be foreclosed on if the loan is defaulted, the Board recommends using a HELOC only for necessities and important expenses.

  • Requirements

    The main requirement to open a HELOC is ownership of a home in which there has been a buildup of equity. This can vary, depending on the housing market. Rising home values mean more equity, while dropping home prices have a negative impact. Other specific requirements may vary among banks, but the borrower is typically required to have a good credit rating.
  • Time Frame

    The repayment terms for a HELOC are typically flexible and can be worked around the borrower's requirements. The borrower and lender will agree to "draw period" that usually lasts from 5 to 25 years. During that time, the borrower can tap into the line of credit and she will be required to make a minimum monthly payment that is based on how much she is using and the interest. At the end of the draw period, she must pay back the full amount that was borrowed. This may be down in one large, lump-sum payment, or it may be drawn out over a period of time specified by a loan amortization schedule.
  • Costs

    Taking out a HELOC requires the borrower to pay a variety of costs related to setting up the loan. According to the Federal Reserve Board, these include the cost of a property appraisal. This will be conducted to estimate the current value of your house. It also includes an application fee, usually non-refundable, so even if you are turned down for the loan, you will not be reimbursed for this fee. Finally, there are closing costs to complete the loan. Typical closing expenses include a title search, attorney fees, property insurance, title insurance, preparation and filing of mortgage documents and any applicable taxes.
  • Warnings

    The interest rate on a HELOC is usually variable and tied into an index such as the prime interest rate. This means it is likely to change over time and can potentially increase significantly. Because a home equity line of credit uses a house as the collateral, defaulting on such a loan can lead to foreclosure of the property. A homeowner should understand this potential consequence if he ever fails to make the payments. In difficult financial times, when home values are falling, homeowners should avoid taking out a home equity line of credit. As prices fall, their equity will be reduced, and they may face a greater risk of foreclosure. Negative economic conditions can also cause lenders to freeze, reduce and even close down the home equity credit lines that they have extended to their customers.
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