What is a Home Equity Line of Credit?

A home equity line of credit is an amount of money a lender is willing to lend to a homeowner using the homeowner’s property as collateral. Home equity line of credit is often abbreviated as HELOC. Most banks figure a home equity line of credit by using the appraised value of the home, minus the amount of money you still owe on the mortgage. If the appraised value is $100,000 and you still owe $75,000, then there is $25,000 equity in the home. Most banks will allow a homeowner to borrow up to 75 or 80 percent of the equity, or $18,750 to $20,000 available as a home equity line of credit.

Additionally, lenders also take into consideration the borrower’s ability to repay the loan. The lender determines this by looking at the borrowers income, debts and credit score.

A HELOC usually has a set period in which the borrower can use the credit line. A common time frame is 10 years. Once the 10 years is up, the borrower must renew the HELOC if he wishes to continue using the line of credit. This period is called a “draw period.” Some plans do not allow the borrower to renew the home equity line of credit. Also, some HELOCs require that the balance due at the 10-year mark is paid in full. Or there may be a set repayment period to allow the borrower to pay off any existing balance.

There are various ways to draw money from the home equity line of credit. Some lenders give the borrower special checks and some issue a credit or debit card. Depending on the lender, you may have to borrow a minimum amount each time you want to draw on the home equity line of credit. Some lenders may require you to keep a minimum outstanding balance.

There are costs involved with setting up a HELOC. These costs include an appraisal fee, an application fee, points and closing costs. Closing costs include attorney’s fees, title search fee, mortgage preparation fee, filing fees, property and title insurance and taxes.

The borrower should also know what the annual percentage rate is for the HELOC. HELOCs generally have variable rates. The rate is based on an index such as the LIBOR. It may also be based on a U.S. treasury bill rate. The APR for the HELOC will change according to the changes in the index. Percentage points are also attached to the rate. If the rate is x percent, the APR on the HELOC will be x percent plus y percentage points.

Learn more about the different types of mortgage loans available.

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