Home Equity Lines

HELOC is an abbreviation of Home Equity Line of Credit. This refers to a loan in which the lender agrees to lend a maximum amount within an agreed period. This differs from a conventional home equity loan in that the borrower is not advanced the entire sum up, but uses the line of credit to borrow sums that total no more than the amount.

A HELOC in many ways is similar to a credit card. At closing you are assigned a specified credit limit that you can borrow up to - not a check. During a "draw period" (typically 5 to 25 years), HELOC funds can be borrowed "on demand" and you pay back only what you use plus interest. Depending on how much you use the HELOC, you will have a minimum monthly payment requirement (often "interest only"); beyond the minimum, it is up to you how much to pay and when to pay. At the end of the draw period, you will have to pay back the full principal amount borrowed either in a lum-sum balloon payment or according to an loan amortization schedule.

Another important difference from a conventional loan: the interest rate on a HELOC is variable based on an index such as prime rate. This means that the interest rate can - and almost certainly will - change over time.

HELOC loans have become very popular in the United States in recent years, in part because interest paid is typically (depending on specific circumstances) deductible under federal and many state income tax laws. This effectively reduces the cost of borrowing funds. Another reason for the popularity of HELOCs is the flexibility not found in most other loans - both in terms of borrowing "on demand" and repaying on a schedule determined by the borrower. The underlying collateral of a home equity line of credit (HELOC) is the home.

 

For a cash-out refi to make sense, mortgage rates have to have dropped, and property values must have risen. This has been the case for millions of homeowners in the early years of the 21st century. A cash-out refi replaces your current home mortgage and the cash you receive is given in one lump sum that is paid off over a set amount of time, with a fixed interest rate and the same payments each month. Once you get the money, you cannot borrow further from the loan. A home equity line of credit, or HELOC, works more like a credit card because it has a revolving balance. A HELOC allows you to borrow up to a certain amount for the life of the loan -- a time limit set by the lender. During that time, you can withdraw money as you need it. As you pay off the principal, you can use the credit again, like a credit card. Like mortgage debt, equity lines offer tax benefits in that the interest paid is tax deductable for equity lines up to $100,000. If you prefer to leave your first mortgage intact, an equity line may be viable option for you.

People borrow against their home's equity for myriad reasons. The two most common are to pay for home improvements and to consolidate debt. Other uses for equity money: to pay tuition, medical expenses, living expenses during unemployment, and big-ticket purchases.

 

Home improvements: Making upgrades and repairs to a house can make the home safer, more energy efficient, more comfortable, better looking, or a combination of those things. It can increase your home's value.

This is an efficient use of equity debt -- deploying it in such a way as to make the house more valuable. If you want to spend equity money to prepare the house for sale, make sure you apply for the loan before putting the home on the market. After you officially put your house up for sale, you will have trouble finding a lender willing to extend the loan.

 

Debt consolidation: Many people rack up a lot of credit card debt and turn to home equity to ease the burden by using their equity to consolidate debt. Doing this can reduce monthly interest charges, because credit card interest rates often are more than 10 percentage points higher than rates on home equity loans and credit lines.

There's a dark side to using equity to consolidate other debts.You might be tempted to run up the credit card balances again, leaving you with big debt and no equity. It might be best to cut up all but one or two cards, stop carrying them with you, and use cash more often.

 

Education: Sometimes, the easiest way to pay tuition and fees for the kids' private school, or for college or technical school, is to turn to home equity. This is especially true for families whose incomes are too high to qualify for grants or student loans. There are also student loans for this purpose.

 

Medical expenses, unemployment, big-ticket purchases: An equity loan can be a godsend if you are hit with thousands of dollars in medical bills or you lose your job. Tax advantages and lower interest rates also make equity loans an option when financing a car, motorcycle or some other high-priced purchase. Many a homeowner even uses equity in the primary home to make a down payment (or the entire purchase price) on a vacation home.