The Home Equity Line of Credit uses the home equity as collateral. This depends on the credit that is
available on your home equity, debt to income ratio and your credit score. This is called as HELOC in
short. Here in this article, I explain about Home Equity Line of Credit and how it is different from
home equity loan.
What is a home equity line of credit?
In simple terms, home equity line of credit is a loan. Here the lender lends maximum amount taking
the home equity as collateral.
How does HELOC work?
The Home Equity Line of Credit works just like your credit card. It allows you to borrow continuously.
However, the interest rate changes based on market conditions.
There are two phases in a HELOC. They are the draw period and the repayment period. The draw
period is the first phase. During this phase, the Home Equity Line of Credit is opened for the user.
You can keep drawing money as and when needed during this phase. However, you need to make
minimum repayments and interests on what was borrowed. In order to extend your draw period,
you need to refinance. If not you will enter the next phase, called the repayment phase. In this
phase, your access to the credit amount is closed. This means you can no longer borrow money. And
you need to repay your principal and interest.
What are the pros and cons of using HELOC?
With Home Equity Line of Credit, you can borrow money continuously. You need not reapply for
loans repeatedly. You can borrow the exact money that you need and pay back only that amount
and interest. HELOC offers flexibility in repayment. Also, with Home Equity Line of Credit, you shall
convert a portion of your repayment into fixed rate.
The main drawback around this type of line of credit is that the interest charges and loan payments
fluctuates here. People tend to overspend as they have continuous access to credits.
How is HELOC different from home equity loan?
Both home equity line of credit and home equity loans are secured over the home. Both have better
interest rates as compared to credit cards and personal loans. This is because they are secured using
the home as collateral.
In home equity loans, the borrower pays a lump sum as down payment. Later he pays fixed
payments at fixed intervals of time to repay the loan. The interest rates of home equity loans are
also fixed. On the other hand, HELOC has variable interest rates. The repayments are also not fixed.
How do I choose between home equity loan and a HELOC?
You should go for home equity loans for one-time expenses and HELOC to cover your costs. Also,
you may choose Home equity loan during following situations:
When you have a precise amount in mind that you want to borrow.
You know about your monthly payments.
When you have a need for a lump sum upfront
You have a good credit score. Credit score is a value between 300 and 900.
It is calculated based on your credit history. A good credit score should be between 700 and 900. You
receive this credit score when your credit payments are regular and your history of payment
is good. It means the banks or the lender is at lower risk while offering a loan to you.
You can choose HELOC during following situations:
When you want to borrow a little, then borrow again after paying a minimum.
You can use it for long term expenses like education and you do not know what exactly the
loan amount should be. For instance, you take HELOC for your education in your first year of
college. And you do not know what the third and fourth semester fees will be. You can take
it during such scenarios.
You should have a good credit score
You should have a little knowledge about the market. When the interest rates will change
and on what basis will they change.
The Right Time: To choose HELOC or Home Equity Loan
Before making the decision, calculate your financial needs. How much money do you need now?
What is your plan of using it? Then consider the monthly payments, interest rates, tax advantages
and fees.
It is always a wise and powerful choice to use HELOC. However, you need to remind yourself now
and then that your home is used as collateral. The risks are high.
Hope my article on Home Equity Line of Credit was helpful!