HELOC or Home Equity Line of Credit
A home equity line of credit or HELOC as it is commonly referred to is simply what it says. It’s basically a line of credit similar to a credit card which allows you to use your home as collateral. This gives you a better interest rate on the loan than a credit card, but puts your house as risk instead of just your credit score.
Usually HELOC’s are taken as second mortgages on your primary residence. At the time of closing the lender sets a specific credit limit on the loan based on the equity you have in the home. For example if your home is valued at $200,000 and you currently have a mortgage of $150,000 on the home you have about $50,000 equity in your home. Many lenders will let you borrow up to 95% of the value of the home so your line of credit may be as much as $47,500.
Once the HELOC is established you can usually write checks from the account, use a special type of card similar to a debit or credit card, or other methods to withdraw money from the credit account.
The interest rate on a HELOC is a variable rate and the terms of the loan are established at the time of closing. Terms can be extended as much as 30 years so payments on the loan are lower.
An alternative to a HELOC is a simple second mortgage which is the same pricipal except you get the money in a lump sum. The interest rates can be variable or fixed and terms can be about the same as a HELOC.
As with any type of loan there are advantages and disadvantages. The advantages of a HELOC is the flexibility of having extra money avaliable at a moments notice with a lower interest rate than a cash advance on a credit card. You only have to withdraw the exact amount from the account, thus paying interest only on the amount you borrow. Also closing costs or up front costs are usually much lower than a second mortgage.
There are of course disadvantages or risks involved with a HELOC. Disadvantages of a home equity line of credit include rising interest rates from month to month. Since the interest floats or is variable it can increase a certain amount each month causing your payments to inflate each month. There are very large caps on the interest rates on a HELOC. Most max out at or above 18%!