Understanding a Home Equity Line of Credit

by Dawn Handschuh, Personal Finance Writer Archive

If you're a homeowner, a home equity line of credit (HELOC) can provide you with easily accessed cash for major expenses, like home improvements. As a secured loan, a HELOC establishes a line of credit by using the equity in your home as collateral. (Your home equity equals the home's current market value minus the unpaid portion of your mortgage.)

Homeowners also use a HELOC as a financial safety net in emergencies, such as a job loss. (Unfortunately, falling real estate prices have turned some borrowers "upside down," meaning that their total mortgage debt is greater than their home's market value, leading some lenders to reduce or suspend HELOC advances.1)

HELOCs can be an appealing alternative to other personal loans, with much lower interest rates than unsecured loans and the added advantage of tax-deductible interest payments.

HELOCs have some disadvantages; by far the biggest is the possibility of losing your home if you default on repayments.

The ins and outs of a HELOC

  • Typically, your lender will give you a checkbook or credit card to access your cash loan. You can spend this money whenever you like (within a specified timeframe), and you pay interest only on spent funds.
  • Many HELOCs start with a short-term fixed interest rate, then convert to a variable rate.
  • HELOCs are approved for a specific amount of credit, based on a percentage of your home's appraised value minus your mortgage balance. Lenders also look at your income and other debt, like unsecured loans.

HELOC cash loans may include fees for the:

  • Property appraisal
  • Application
  • Point(s)
  • Attorney
  • Title search
  • Annual maintenance
  • Transactions

What to look for when considering a home equity line of credit

HELOC personal loans come in all shapes and sizes, especially when it comes to repayment, so look at several plans.

  • Read the fine print that discloses loan terms and conditions, including the annual percentage rate (APR).
  • Compare closing costs among lenders.
  • Ask lenders how high rates have previously risen. (Some plans cap rates; some let you convert a variable rate to a fixed rate.)

Footnotes
1 "Homeowners Losing Equity Lines," Washington Post, February 23, 2008