A home equity line of credit (HELOC) is like a credit card that uses your home as collateral. It is not a “loan,” per se, and is very different from a “home equity loan.” Since a home is one of the largest assets most people have, many homeowners make use of their home equity credit line for major purchases, such as home improvements, education, medical bills and paying off other debts.
Once you are approved with a home equity line of credit program, you will be assigned a particular credit limit. The majority of lenders determine the credit limit by establishing a percentage of your homes appraised value and subtracting the amount you owe on your current mortgage.
There are also additional factors that will determine the value of your credit limit. The lenders will consider your ability to pay by analyzing your income, other debts, credit history and financial responsibilities.
All HELOCs are established for a fixed period. During this period, such as 5-10 years, you can borrow money so long as it is below your home equity credit limit. When the term ends, you may be able to renew the home equity line of credit. However, some HELOCs do not offer renewals and once the period has ended, you are not eligible to borrow any additional money. Other lenders allow repayment for an agreed fixed period.
Usually, the draw period is set to five to ten years with a repayment period of ten to fifteen years. However, each lender could set its own draw and repayment periods. The most common draw periods are nine years and six months. The most common repayment period is twenty years.
Once you have been approved for a HELOC, you will have the benefit of borrowing up to your limit anytime. To use your HELOC, you are given special checks and a credit card. The checks are “special,” and do not have routing numbers that allow them to be used to pay by telephone or on the Internet. They simply don’t work. But the credit card will. You pay interest only on the amount used, or “borrowed;” whereas on a home equity loan, you must pay interest on the entire loan for the full term or until the loan is paid off. For this reason HELOCs are the product of choice.
Some home equity lines of credit set limitations on the usage of the HELOC. Most home equity lines also have a minimum amount required for writing one of the special checks, such as “$300.” Some HELOCs even oblige you to draw your first advance as soon as the line of credit is set up.
Of course, just like any other investment, there may be costs in establishing and maintaining your home equity line of credit. First, there could be fees for property appraisals to calculate approximately your home value. Second, most lenders require an application fee that generally cannot be refunded if your application is denied. There are ways to avoid these fees.
In addition, you could be assessed closing costs such as title search, attorney fees, title and property insurance, additional taxes, and preparation and filing of mortgages. Once you have received your HELOC, there may also be other fees during the plan period. These may include maintenance or annual membership fees and transaction fees with withdrawals.
Although with all of these fees, you could spend hundreds of dollars, since your home is used as collateral, your annual percentage rate becomes extremely lower than any other type of credit. This interest could allow you to offset all the costs of maintaining and establishing the HELOC. Sometimes, the lenders waive a little or even most of the costs for closing the deal.