What is a HELOC?
Homes symbolize many different things, including an investment in one's future. Bank of America says a home equity line of credit, often referred to as a HELOC, is a line of credit secured by your home. It is a revolving credit line that can be used for various expenses. The Credit Union of Southern California reports that a HELOC credit line is issued by a lender and has a limit and variable interest rate secured by the equity in your home.
A HELOC is similar to a credit card in that they both provide revolving credit. Investopedia says revolving credit is an agreement that permits an account holder to repeatedly borrow money up to a set dollar limit while repaying a portion of the current balance due in regular payments over time. But unlike credit cards that may have high interest rates, the interest rates of HELOCs often are lower — a significant advantage when paying off large amounts of borrowed money.
Home equity accessed through a HELOC can be a great source of value for future renovations, large purchases such as cars, educational expenses, and alternative debt repayment. The credit limit of a HELOC depends on your credit standing and unpaid debts. The home's market value and how much you owe on your mortgage also contribute to the interest rate.
According to Credit Karma, banks tend to limit the amount borrowed to no more than 85% of the home's appraised value, minus what is owed on the mortgage. HELOC terms also vary, but they can run for as long as 30 years.
Even though there are many benefits to HELOCs, there is a downside to using a home as collateral. Investopedia says home equity lenders place a second lien on the home (in addition to the first mortgage lien). Defaulting on HELOC payments can result in legal action and a home being repossessed. Another potential pitfall is a lender may reduce or freeze your credit line after missed payments. Even though banks attempt to limit how much can be borrowed through HELOCs to help avoid potentially negative situations, they are not without risk.
Borrowers considering a HELOC have other options, including home equity loans. Homeowners can speak with financial advisors to learn more about their options for maximizing the equity in their homes.