About Home Equity Lines of Credit

Home equity lines of credit are revolving debt accounts that function much like credit card accounts. However, they usually have much lower interest rates because the debt is secured by the equity in your home. Unlike a traditional home equity loan, you don't borrow the entire amount at once. Instead you use a special check or credit card to charge against the home equity line of credit as the need arises.

Lenders determine the size of a home equity lines of credit based on a percentage of the market value of the home minus the outstanding mortgage principal. For example, if a house is worth $200,000 and the lender allows up to 80% and the mortgage principal is $100,000 the line of credit can be up to $160,000 minus $100,000 or $60,000. Lenders reserve the right to reduce home equity lines of credit if the value of the home falls, so once a line of credit s set up the limit isn't "written in stone."

One difference between credit card and HELOC accounts is that the latter are usually set up for a specific period of several years called the "draw period." At the end of that time no further charges can be made to the account unless the line of credit is renewed. Some plans call for he balance (if any) to be paid at the end of the draw period. Interest rates are usually variable and tied to an index such as the prime rate. However, federal law requires a cap on HELOC interest rates so they can rise only to a certain point. Some home equity lines of credit allow you to convert part or all of the balance to a fixed rate.

Setting up home equity lines of credit can cost several hundred dollars because they involve using real estate as collateral. You will have to pay for an appraisal of the house, closing costs, and an application fee. You may be assessed "points" (an upfront charge) as well. An annual maintenance fee and transaction charges may apply. Most people only choose to open a home equity line of credit for major expenses so the savings on interest will be enough to offset start-up costs.

When you have a home equity line f credit you are putting your house up as collateral. If you fail to repay the money you borrow you can lose your home. There are some other possible disadvantages as well. If the value of your home falls as many did in 2008, the bank can freeze home equity lines of credit or rescind them entirely. Another problem can arise if you decide to sell a house because you may have to pay the entire balance of the home equity line of credit immediately.