A home equity line of credit or HELOC is a type of loan that a home owner can take out against the value of their home. A HELOC functions like a credit card; a borrower and lender agree to a maximum total amount, and an interest rate based on the outstanding balance used at any time. From there a borrower is free to use the extended credit as he pleases, with his home acting as the collateral. In many cases, a lender will even issue a credit card linked to the home equity line of credit as a means of accessing your new funds.

A home equity line is usually 60%-80% of the difference between how much your home is worth and how much you owe on it. For example, with good credit, if your home is worth $100k and you owe $40k on it, a bank would take the difference of $60k and multiply it by 80%, giving you a credit line of $48k.

For many people, HELOCs give them a way to pay low interest rates on large expenses, such as college tuition, home improvements, or paying off credit cards and other debts. Because the interest on a HELOC is partly tax deductible, it can prove cheaper than many other types of loans. An equity line is also far more convenient and timely than many other types of loans, because their duration is often 15 to 20 years. Rather than trying to take out a loan against your house during a crisis, you can use an open HELOC to temporarily finance your expenses.

They have significant downsides though, too. Unlike other types of home equity loans, HELOCs are not available at a fixed rate. With constant fluctuations in the lending market, your rates could change often, and unpredictably. Most HELOCs also contain cancellation conditions, where a lender can end an unused credit line at their discretion; without returning any of the money a borrower paid to secure the credit line originally. This can become an issue especially if your home value drops, which happened to many homeowners during the Great Recession.

HELOCs can prove to be a convenient, low cost way to finance large expenses. But they also have the potential to get expensive if interest rates rise, and can’t be relied upon if they go unused. Deciding whether to take the risk is something each potential borrower will have to weigh before taking out a HELOC, but if you can get a HELOC without paying any fees, it doesn’t hurt to have one on standby.

add comment – May 11, 2012 – flag