How does a Home Equity Line of Credit (HELOC) work?
Tuesday, 24 April 2018
A home equity line of credit—also known as a HELOC—can be a great personal finance tool.
For homeowners who have equity in their property, a HELOC can be an affordable and convenient line of credit. But how does it work?
How to apply for a home equity line of credit
First, property owner has to apply for a HELOC with a lender. The lender considers the property's market value and outstanding debts against the home, as well as the borrower's income, credit score, and other outstanding debt.
If approved, the borrower pays fees for the transactions that can include fees for the appraisal, title insurance, and similar items. These are commonly referred to as the upfront costs or closing costs.
Typically, a bank may extend credit up to 80 percent of the home's value, minus the outstanding mortgage. For example, if a house appraises for $300,000, and the borrower has an outstanding $200,000 mortgage, a typical borrower may qualify for a $40,000 HELOC.
To access this money, the borrower is issued special checks, and/or a debit/credit card. Expect the lender to establish requirements for withdrawals, including a minimum on any sum you withdraw, an initial draw, and a minimum outstanding balance you must maintain.
Borrowing and paying
The borrower has a certain period of time during which they can take out the money—typically up to 10 years. This is the draw period. During the draw period, it's required that monthly payments be made, though these payments are usually interest-only.
There is another established period of time to repay the balance, which includes both the principal and interest. A HELOC is different from a home equity loan; it's a revolving line of credit, and the borrower does not have to use the entire sum available, but can instead borrow against it as needed—much like a credit card.
The borrower must pay off the HELOC balance in the event the property is sold, or by the maturity date. Since the credit line is a lien against your home, defaulting on a HELOC can put the borrower at risk of home foreclosure.
Understanding your HELOC offer
HELOCs are usually variable rate, meaning they fluctuate as rates go up and down. When comparing different HELOC offers, it's important to ask whether the rate offered is a discounted rate or an introductory rate—meaning it's a lower rate for a fixed period of time, typically for 3 or 6 months.
Like with any financial product, it's important to shop around to find the best deal and talk with a trusted financial advisor before making any decisions.
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