Just what is a HELOC?

HELOC stands for Home Equity Line of Credit. It’s a credit line offered by a bank with the borrower’s property equity serving as collateral for the loan. The equity is the difference between the market value of the property and the amount still owed on mortgages or other encumbrances.

For instance, if you owe $ 70,000 on your home, and the value is $ 250,000 you have an equity value of $ 180,000. On the basis of equity, the lender typically might offer a HELOC that the borrower can draw against for five to ten years, with a repayment of up to twenty-five years.

Should HELOC be thought of as a type of credit card or a loan?

A HELOC is essentially a hybrid between a credit card and a second. Just like credit cards, lenders allow you a spending limit (i.e., the amount of equity) and you have to pay according to the amount of credit that has been used. Each time credit is taken up the amount of credit available declines, but it increases again with repayments. That said, a HELOC is secured debt whereas a credit card isn’t.

Pledging real estate as security makes a HELOC akin to a second mortgage, but there IS a difference. When you get a second mortgage, the lender gives the borrower the entire loan in a lump sum, but a HELOC is disbursed to the borrower on an installment basis by need.

What are the advantages of a HELOC compared to other kinds of loans?

The advantage of a HELOC is that they are suitable for infrequent but major expenses for a household. Common examples include financing a home addition, and paying for a child’s college tuition or wedding expenses. With the current, low prime interest rates HELOCs can provide inexpensive financing. Also, borrowers may additionally qualify for tax deductions on HELOC repayments.

For some borrowers, the HELOC can provide an economical means of debt consolidation. You might find it significantly cheaper to pay the interest on the HELOC rather than to continue paying several lenders their interest charges, administrative costs and delayed payment penalties.

Disadvantages of taking out a HELOC

The attractiveness of taking out a HELOC in certain circumstances needs to be balanced against the risks. If the HELOC carries a variable interest rate, Borrowers should be aware that interest rates can change to their disadvantage. Futhermore, failure to make payments would mean that people might lose their homes.

If you use a HELOC to consolidate debts, remember it is common for banks to charge closing fees for people paying off loans, and that expense should be taken into account when you calculate your savings. Some HELOCs liability for any deficiency stays even after the bank has foreclosed on a secured home. Another risk is that banks have the right to terminate an unused credit line if property values decline and therefore reduces the borrower’s equity.

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