Home Equity Lines of Credit (HELOCs)

A Home Equity Line of Credit, also known as a HELOC, is an open-ended loan that is secured by real property. Like a credit card, it is a revolving line of credit which allows the consumer to borrow only the amount that he or she needs (up to a predefined limit), pay it off and have that credit available to use again. Helocs have become very popular during the last several years of unprecedented refinancing by homeowners, due at least in part to the flexibility that they offer. They also tend to be somewhat easier for the homeowner to obtain because they are primarily underwritten based on the value of the property. In other words, the borrower need not have the highest credit score as long as there is sufficient equity in the property to make the loan.

Helocs are generally specialized adjustable-rate mortgages, meaning that their interest rates are tied to a certain financial indicator, or index, and can fluctuate up or down, sometimes quite quickly. The monthly payment will therefore also fluctuate. Some lenders do, however, offer fixed-rate helocs. But even though the interest rate remains the same on these, the monthly payment can still fluctuate based on the amount of money that was borrowed during the previous month. Some lenders will also convert the helocs that they offer from adjustable- to fixed rate, for a fee.

Most helocs are usually used as second mortgages and, as such, have a 20-year term. The first 10 years of the term are known as the draw period. During this time the line of credit can be used over and over again, up to the credit limit. The borrower can pay off the full amount borrowed, or make interest-only payments during the draw period. Once the draw period ends, however, the borrower can no longer take money out of the line of credit. If there is an outstanding balance at the end of the draw period, the borrower’s payments become amortized to pay off the loan within the remaining period of the term.

Helocs have the advantage of allowing the borrower to use and pay for only the amount that is needed at the time. Interest payments are also usually tax-deductible, which makes the cost of borrowing funds lower. High interest non-deductible debt (such as credit cards and car payments) can be converted to tax-deductible debt. Use our handy Should I Use Heloc to Lower My debt Payments? Calculator to compute your possible savings.

There are possible disadvantages which must be addressed, as well. A heloc’s adjustable interest rate could rise, taking the borrower’s monthly payment along with it. And, after having made interest-only payments for the entire draw period and not paying any of the principal, a homeowner could find him- or herself stuck with a large principal balance to pay back, and with only 10 years to do it. This could make for a quite hefty loan obligation.

However, handled with the proper knowledge and prudence, a heloc can be a very useful financial vehicle for the homeowner that can utilize its unique capabilities. Here are several more useful articles about helocs. Remember, educate yourself!