What is a Home Equity Line of Credit?
Loan Secured by Property Value is Safe But May Damage Credit Rating
Jun 15, 2009
People looking for a source of cash to finance home renovations, investments, school tuition, or to buy a new property can turn to a home equity line of credit, a loan that relies on a home as collateral and offers lower, variable interest rates.
Home Equity Line of Credit Definition
A home equity line of credit, also known by the acronym "HELOC," is a loan that relies on a home or other property as collateral. If a borrower defaults on paying back the loan, the bank or other lender can seize the property in place of the money they are owed.
Home equity lines of credit allow homeowners to borrow money at a lower rate than an unsecured loan, and to withdraw that money on a credit line that operates similarly to a credit card.
Depending on the bank or lender, a home equity credit loan can be secured for as much as 75-90% of home equity owned – namely, of the total value of the home minus any outstanding mortgages. A home equity line of credit is usually only possible for homeowners who have at least 10-20% equity in their home.
Who Uses a Home Equity Line of Credit?
Home equity lines of credit can be used by a homeowner to pay for any large purchases or needs. Some of the most popular reasons to request a home equity line of credit include:
- Purchasing a second home or a rental property
- Home renovations that will improve the house's value
- Paying off other, higher-interest debts
- Paying for a child's college or university tuition
- Buying a car or RV
- Planning a special vacation
- Capitalizing on an investment opportunity
- Supporting oneself or one's family in a lean time between jobs
Home Equity Line of Credit Pros and Cons
A home equity line of credit may look like a perfect financial solution, but anyone considering this type of loan should keep a few things in mind.
Home equity lines of credit are very flexible, allowing borrowers to withdraw money against the line of credit up to their maximum, pay it off as they are able (most HELOCs require only interest until the loan comes due), and remain available to be drawn against even once they are paid in full. Like a credit card, it's not necessary to reapply to use the line of credit again for further withdrawals and projects. This makes a home equity line of credit ideal for anyone who may want to borrow money – and pay it back – piecemeal over a period of time.
Home equity lines of credit are usually offered at a variable rate, which means the interest rate can change with the economy. This can mean that monthly payments will vary widely if the market changes. These interest payments are also deductible under many tax laws because they are related to the home.
Lines of credit that require only interest payments until they are due (the term can be anything from 5 to 25 years) can be problematic for people who don't plan ahead, so it's always a good idea to pay down interest and principal on a loan as quickly as possible.
As a final consideration, withdrawing most of the available money on a line of credit can negatively affect credit score – so if credit rating is an important factor, this may not be the best option. But the impact is relatively small, so it shouldn't deter most people from using a home equity line of credit if they have the ability to pay it off.
Sources
- CIBC, "CIBC Home Power Line of Credit," CIBC.com, accessed 15 June 2009.
- Tamkin, Samuel J. and Ilyce R. Glink, "Treat delicately before tapping HELOC – it could damage your credit," OrlandoSentinel.com, 15 June 2009.
- TD Canada Trust, "Home Equity Line of Credit," TDCanadaTrust.com, accessed 15 June 2009.
- The Financial Blogger, "The Home Equity Line of Credit," TheFinancialBlogger.com, 25 February 2007.
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