How does a home equity line of credit work?

When asking what a home equity line of credit is we need to point out that a HELOC, as it is called in the industry, is different than a home equity loan. A home equity loan is where you apply for a lump sum to use towards certain needs you may have at that particular time. Once you receive the check, you spend it and pay back the loan monthly with interest. A home equity line of credit differs in that you are being offered a lump sum in the form of credit that can be used at any time during the term of the loan and you only pay back what you have used plus interest.

To simplify a HELOC with an example would go like this. You have 50,000 dollars in equity in your home and decide you need to fix your roof. You apply and are approved for a HELOC in the amount of 25,000 dollars for a 15 year term. This money will be the line of credit you draw upon to fix your roof that costs 5,000 dollars. You then take 5k from your line of credit and won’t be touching the rest to pay the bill. You will then pay back the 5,000 dollars plus interest through monthly payments and still have plenty on your line of credit if you need to use it sometime over the years for more repairs.

The downside to a HELOC is that your home is the collateral and there can be a few negatives to that in some cases. If you default on your line of credit payments, they can foreclose on your home. The negative aspect that is completely out of your control is that a decline of the housing market and value of your home by 50 percent, as we saw during the housing crash, can lead to your line of equity being frozen by the bank. This is a slight possibility so consider your area's housing market value before going this route.

Outside of those two negatives, a HELOC is a great way to have money at your disposal for any unforeseen issues that may arise in the future. It can be easier to handle financially as well considering you are only paying off what you use, as opposed to a lump sum as you would with a home equity loan.

A Home Equity Line Of Credit (HELOC) is an amount of money extended to you by a lender that you can use at your disposal.  As the name implies, you must use your house as collateral in order to secure the loan. HELOCs have become popular because they are simple, flexible, and allow a borrower lee-way to make large new purchases at low rates. Here is a breakdown on how a HELOC works:

1. Getting a HELOC –To get a HELOC you have to apply for a home line of credit with a lender. They will decide on your maximum credit line by taking the value of your home, and subtracting any mortgages you have against it; then they will multiply that number by a percent between 60%-80% based on your credit history. That amount will become your maximum credit line.
2. Using a HELOC –You can access your credit line just line a bank account. Most lenders will issue checks and a MasterCard or VISA card that will allow you to make purchases using your new credit. You can make new purchases with your line of credit for a specific amount of time called the ‘draw period’. Most draw periods are 10 or 15 years; and some HELOCs allow renewal of the draw period after it has expired.
3. Costs –singing a HELOC requires you go through the normal mortgage process, though in some cases you might be able to open a HELOC without any cost to you. The largest cost of HELOC comes from the interest rate, which is calculated daily on your current balance (obviously there is no cost for days you maintain a zero balance). Nearly all HELOCs have adjustable interest rates.
4. Paying Back – a home equity line of credit functions like a credit card, each month you will receive a statement containing your minimum monthly payment. Most HELOCs allow you to carry your balance after the ‘draw period’ has ended, although others require payment in full at the end of the term. Like other loans against your home, HELOCs can lead to foreclosure if you do not make your minimum required payments.