A home equity line of credit (also commonly known as a HELOC or home equity loan) is similar to a second mortgage in that the security for the loan is the borrower’s equity in their property. The lender will agree to lend an amount to be spent as a line of credit within a term at a low interest rate. It is a fairly easy loan to get and is often used as a form of debt consolidation to pay off loans with higher interest rates.
What makes it different?
Home equity lines of credit are different than a tradition loan in that the borrower does not receive the whole amount up front. The borrower is given a line of credit which they can use at their leisure without going higher than the credit limit. The concept is very similar to a credit card. Payments usually contain the amount that was drawn from the line of credit plus interest. The line of credit can be set up with a monthly payment system in which the payment is mostly interest but the borrower can pay back any amount larger than the minimum payment if they so choose.
Interest rates typically vary in home equity lines of credit. The interest rate is based on a certain guide like the prime rate. Therefore, the interest rate can change based on economic factors.
Why a home equity line of credit?
Home equity lines of credit are usually used for debt consolidation or every day spending but there are always advantages and disadvantages to a line of credit.
- Opening a home equity line of credit to consolidate debt can greatly reduce the cost of borrowing
- Interest rates are much lower and usually close to the prime rate
- A great and affordable way to get funds for short term requirements
- The money in a line of credit is easily accessible
- Can be a good emergency fund
- Home equity lines of credit have a better reputation than taking out a second mortgage
- The collateral on the line of credit is your home, so if you cannot may payments you can risk foreclosure
- The flexibility of repayment and easy access to funds can be dangerous for a borrower if not used responsibly
- Because of the ease of increasing the credit limit it is easy to get caught in a spiral of debt
- Creates a reliance on credit versus saving and relying on your own cash savings
How to use a Home Equity Line of Credit
Home equity lines of credit can be used in several ways. The most popular ones are debt consolidation, emergency funds and everyday cash.
With the proper discipline to make payments on your line of credit, it is a great way to consolidate your debt and lower the interest cost of borrowing
If you are low on cash and have opened a home equity line of credit it is a great way to get the money you need for an emergency
Every day cash use:
Some people use home equity lines of credit as an ATM. Many people have taken out lines of credit for frivolous expenses like new cars or vacations. Home equity lines of credit are believed to be one of the reasons for the subprime mortgage debacle in the United States.