A home equity line of credit, which is also known as a HELOC, functions similar to a credit card. It is a line of credit that uses the equity in your home as collateral. In other words, you can use your home value and turn it into cash that you can access when needed
HELOCs usually allow you to borrow up to 85% of your home’s value, excluding the outstanding balance on your mortgage.
For example, let’s say your home has a value of $200,000 and a mortgage balance of $75,000. 85% of $200,000 is $170,000. If you subtract your outstanding mortgage balance from $170,000, you may qualify for a credit up to $95,000.
Most people use a HELOC to make home repairs, renovations, or pay down high-interest debt. In general, HELOCs have better interest rates than traditional credit cards, but the interest rate may be adjustable.
HELOCs have two separate payments periods
During the draw period, which is typically about ten years, you can withdraw cash on the line of credit whenever you want.
There are two types of HELOCs. One type has an interest-only draw period. You would make payments on the interest accrued, which is only applied to the amount that you borrow. The other kind of HELOC requires payments on both the interest and principal. As a result, you will pay off your loan faster but have higher monthly payments.
After the draw period, your monthly payment is significantly higher. Now, your monthly payment will include the principal amount that you borrowed as well as the interest on that amount. You will continue to make these payments over the remaining loan term, which is typically 20 years.
A HELOC is a revolving line of credit that lets you tap into the equity you have built up in your home, as you need it. This option is better if you do not know the full scope of the amount that you need or if you need to withdraw in phases. Home improvement projects that are broken up in stages or college tuition payments that are spread out over time are good examples of when to use a HELOC.
On the other hand, a home equity loan is a lump-sum withdrawal. It usually has a fixed interest rate that is paid back in fixed monthly installments. This option is ideal for one-time major renovations or as an option to consolidate credit card debt.