HELOC or a home equity line of credit is a borrowing arrangement through which the creditor agrees to extend a maximum amount which is repayable within a specified term. The client’s equity in his house serves as collateral to secure the home. Being the borrowers’ most valuable asset, most people will resort to such type of financing only for major purchases and items (medical bills or university tuition fees). In fact, the abuse of home equity lines of credit has contributed to the subprime mortgage crisis.
There are some differences between home equity loans and lines of credit. With the latter, the whole amount is not advanced up front, but the borrower uses a credit line. He or she can borrow amounts within a credit limit quite like with a credit card. The draw period for HELOC funds is between five and twenty five years, with repayment due on the drawn amount and interest. Some home equity credit lines come with a required minimum monthly payment which is in most cases interest only. The debtor is free to pay off any amount provided that it is larger than the required minimum. The outstanding balance has to be more than the payment made as the full principal is payable at the end of the draw period. It can be paid in two ways, according to an agreed amortization schedule or as balloon payment in one lump sum.
When applying for a home equity credit line, it is important to look at the costs involved in establishing the plan and the APR. The annual percentage rate represents the interest rate rather than different charges and other fees. In some cases, the lender may offer temporary interest rate discounts, referred to as introductory rates. These are available over a short period of time, such as six or nine months. Variable-rate plans, guaranteed by real estate as collateral, have a credit cap or ceiling on the amount of interest increase over the lifespan of the credit plan. With some plans, there is a limit on the increase of the payment amount and the threshold of the interest rate in case that the index drops. Some lenders allow customers to convert from variable to fixed interest rate, letting them convert a portion or all of the credit line to an installment loan with a fixed term.
Once the client has been approved for a HELOC, he or she can borrow amounts within the specified credit limit. Under some plans, the borrower may be required to take an initial advance upon setting up the credit line.