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Overview
A home equity line of credit is essentially a loan that uses the borrower's home as collateral. However, instead of getting a lump sum the borrower is given a line of credit from which he can withdraw sums as needed, up to the total of the loan, over a set period of time.
How Much Credit?
The amount available through a traditional line of credit generally depends on a number of factors, such as debt history, existing debts and credit rating. A home equity line of credit is different. The total of the credit line available is instead calculated using the value of the borrower's house. Most borrowers calculate it at 75 to 80 percent of the appraised value of the house, minus the existing balance of the mortgage. So on a house worth $100,000 the credit line would be worth a maximum of $80,000. If the borrower still owed $45,000 on the mortgage, then the home equity line of credit would be $35,000.
Repayments
Each finance company is different and it is important that the borrower does his research thoroughly before signing up for a home equity line of credit. Some companies only allow the borrower to repay the interest on a home equity line of credit, meaning that when the plan ends a borrower would still owe the entire amount borrowed. Other companies set minimum payments that contribute to both the principal borrowed and accrued interest, however these minimum payments may not be enough to cover the total borrowed. The amount of the minimum payment can also fluctuate depending on whether or not the lender offered a fixed or variable interest rate with the home equity line of credit. Some lenders do offer the option of paying more than the minimum payment, allowing the borrower to pay the principal off quickly in the same manner as a traditional loan.
End of the Plan
At the end of the loan period the borrower will have to pay off either the entire amount borrowed or, if he has been paying off the principal during the term of the plan, the remainder owed in a lump sum, probably by refinancing with the same or another company.
Considerations
If the borrower wants to move during the period of the plan, he will likely have to repay the home equity line of credit in full.
Warning
A home equity line of credit is attractive because it often has lower interest repayments than other loans. However, it is important to remember that since a home equity line of credit is secured against the borrower's house, if he fails to make his repayments then he could lose the house.
