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What Is A Home Equity Line Of Credit?
By EchoBay Loans Staff Writer

A home equity line of credit, also referred to as a HELOC, is similar to a credit card. It is a line of credit that has a fixed maximum amount and the borrower has the option to borrow up to that amount, pay it down, borrow again, etc. The loan is secured by your home, which results in a much lower interest rate than a credit card and can allow you to deduct the interest on your taxes.

A home equity line of credit can be used for a variety of purposes and does not necessarily have to be used for items associated with your home. In fact, in many cases, borrowers use a home equity line of credit to pay for other expenses such as debt consolidation, college tuition or to buy big ticket items such as a car, motorcycle or boat.

There are many benefits to the home equity line of credit including flexibility in buying, possible tax deductions and low interest rates. The downfall to a home equity line of credit is that it is secured by your home. If for some reason, you are unable to make payments, you risk the possibility of foreclosure. It is very important to be careful in assigning additional debt tied to your home.

Maximum allowed
The maximum amount allowed to be borrowed for a HELOC varies greatly by lender and also depends largely on the creditworthiness of the borrower. Some lenders will only lend up to 80% of the appraised value of the home, including the first mortgage and HELOC. For example, if your home is appraised at $200,000, the maximum amount of all debt tied to the home can be no greater than $160,000. If you owe $145,000 on your first mortgage, you would only qualify for a $15,000 home equity line of credit.

Others will lend up to 125% of the home's value. Using the same scenario as above, you would qualify for total debt of $250,000. This would allow you to have a home equity line of credit of $105,000. Lines of credit that exceed a loan to value of 100% are typically reserved for the best borrowers.

Interest rates
The HELOC features a variable interest rate that fluctuates over the life of the home equity line of credit. A common index is the Wall Street Journal Prime (WSJP) rate. The lender also adds a margin to this so your rate may be stated as prime + 2% meaning your rate is equal to 2% higher than the published WSJP rate. When the WSJP increases or decreases, the rate on the HELOC follows suit. Your HELOC will likely feature an interest rate cap. This means that during the life of the loan, your interest rate will not exceed a certain percentage.

Payment plan
The repayment of the home equity line of credit can vary from lender to lender. Generally a certain percentage of principal plus all interest is due each month. For example, a 1.5% principal payment plus interest may be due monthly. Because the payment is based on the amount that is outstanding on the loan and the interest rate is subject to change, payments over the life of a HELOC can vary dramatically. It is also possible to have a HELOC where you only pay the outstanding interest each month.

Up-front costs
Many banks offer no closing costs on HELOCs if the line is drawn immediately and stays above a specified amount for the first six months. For instance, if your initial draw is $10,000 and the balance is maintained for six months, all closing costs are waived. This can vary widely by lender and not all lenders offer these programs. Closing costs on a home equity line of credit can run hundreds of dollars. Your lender should give you a breakdown of the closing costs in writing.

Repayment at the end of the term
At the end of the loan term, refinancing or repayment of the HELOC is expected. Some HELOCs offer the borrower the chance to refinance the outstanding portion to a fixed rate loan. Others may call for immediate repayment. This can present a problem for a borrower who is unable to obtain financing. At this point, the home could be at risk for foreclosure.

A home equity line of credit can be a great financing choice for the borrower who has built equity in their home. Favorable interest rates and tax-deductible interest are two of the greatest draws to a home equity line of credit. Be sure to use your equity wisely in order to protect your investment in your home.


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