'Home Equity Line of Credit (HELOC)' is explained in detail and with examples in the Real Estate edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.
A home equity line of credit is also known by its acronym HELOC. It represents a viable alternative to the more commonly used home equity loan. Whereas home equity loans provide lump sum amounts, Home Equity Lines of Credit provide cash as and when the borrower needs it. The downside to a HELOC is that a bank can decide to reduce the amount of available credit or cancel the line altogether without warning. This can happen before a borrower has utilized the funds.
In a home equity line of credit, borrowers use the equity within the home to be their collateral with the bank. The lending institution decides on the maximum amount that the borrower can obtain. The home owner then determines how much of this they want to borrow for the amount of time the bank permits. This might be until the monthly payments reduce the line to a zero balance, or it could be for a certain number of months. This makes these HELOCs much like a credit card in the ability to draw on the resources only when and as they need them.
The main difference between a home equity line of credit and a home loan is that the former is a revolving loan instrument. Borrowers are able to use the money then pay it off. They can then draw on it once again. Home equity loans pay a single lump sum up front amount one time. HELOCs also feature variable interest rates that will change over time, while home equity loans come with interest rates that are fixed. The payment amounts on the home equity loans are also fixed every month, while the payment on the HELOC depends on how much of the line is used.
In order to be able to obtain a home equity line of credit, the home owner must have significant equity in the house itself. Banks will insist that owners keep at least 10% to 20% equity within the property all the time. This must be the case after the line is approved as well. The HELOC approval process will also require verifiable proof of income, consistent documented employment, and a high credit score that is generally more than 680.
It is important for prospective borrowers to determine what they will use the home equity line of credit money for before they draw on it. Home renovations lend themselves better to home equity loans. This is because the one time large amount would enable the borrower to finish the renovations and then repay the loan. A HELOC is a better fit for a revolving bill such as the children’s college tuition. Borrowers can use them to cover the tuition, then pay them off hopefully before the next tuition payment become due. At this point they can re-utilize the HELOC for the next semester tuition.
The home equity line of credit can also be a good choice for individuals who wish to consolidate the balances on their credit cards which feature high interest rates. The rates for the HELOC are typically much lower. This strategy requires some discipline. Once the credit cards have been cleared, there is the danger that the home owner might be tempted to run them back up again while they are still making payments on the line of credit. This would put borrowers in a worse situation than before they chose to consolidate.
Home equity lines of credit can get a home owner into the bad habit of constantly borrowing and paying them back as with a credit card. This can be a problem if the borrowers take on more debt with the HELOC than they can afford to pay in monthly payments. Missing these payments would put their home at jeopardy of being seized by the bank.