Home Equity Line of Credit

A home equity line of credit (HELOC) is a revolving credit secured by your home. You can borrow a percentage of the equity in your home once the credit line is set up. It is relatively inexpensive to set up. As long as you do not use the limit, it should not cost you anything. It is a powerful tool of credit.

It works like a credit card. The credit limit revolves as and when you repay. Your home serves as collateral. Let us assume that you have a 10,000 line of credit. You borrow 5,000 to pay for new kitchen cabinets. You could borrow another 5,000. Instead of borrowing more from the line of credit, you pay back 3,000. You still owe 2,000, and 8,000 as available credit.

• The lender decides the period of the loan.You can withdraw money to suit your needs during that time limit and within the set limit.

• The money need not be used only for a home-related project. It can finance a college education, the purchase of a new car or the vacation of a lifetime.

Credit limit:

Lenders decide the credit limit on a home equity line based on the appraised value of the home. They lend up to a percentage of the appraised value minus

the balance owed on the existing mortgage. The lender considers your ability to repay, by looking at your income, debts, and other financial obligations as well as your credit history before lending. The lender determines your actual credit limit based on the above.

Highlights of the scheme:

• It offers more flexible options than a home equity loan. You can borrow during the draw period of the equity line. The minimum monthly payments cover only the interest, although you can elect to pay principal. You can pay off, re-borrow and pay off the balance as many times as you like over the life of the credit line, which is typically 5 or 10 years. Payments vary depending on the interest rate, the amount owed and whether the credit line is in the draw period or the repayment period.

• The drawing period is followed by a 10-15 year repayment period. You cannot borrow during this period. It is the period for repayment only. Each lender can set their own table for drawing money and repayment.

• Some plans insist on withdrawal of a specific initial advance when the line is set up.

• The variable interest rate fluctuates over the life of the loan. In contrast, the interest rate is fixed under a home equity loan.

• A line of credit is accessed by check, credit card or electronic transfer ordered by phone.

Advantages:

• A HELOC offers flexible options while a traditional home equity loan is not flexible. A traditional home equity loan is a one-time lump sum loan. It is paid off over a set amount of time, with a fixed interest rate and the same payments each month. Once you get the money, you cannot borrow further from the loan whereas line of credit is drawn as and when required. You can borrow any number of times within the loan period as it is a revolving limit.

Maintenance cost is low:

• It helps a person to tide over urgent and unforeseen tough times. A homeowner on losing his job by chance can still borrow from the home equity line to span the gap until the next job.

• Because these loans are secured by your home they are second mortgages, and the interest that you pay is usually tax deductible.

Some good uses:

• College education: A homeowner can avail the loan for the first child, pay down the balance in time for the next child, then borrow again without having to take out yet another loan.

• It helps meet unexpected home repairs.

• Debt consolidation: The credit helps to liquidate higher-rate debt, such as those on multiple credit cards and towards repayment of a home equity loan.

• It is also availed for major purchases, household expenditures, vacation, medical and business expenses.

What should you look for when shopping for a plan

You must always look for the plan that suits your particular needs. Read the credit agreement carefully, and examine the terms and conditions of various plans, including the Annual Percentage Rate (APR) and the costs of establishing the plan. The APR for a home equity line reflects the interest rate alone (as against interest and other charges for credit cards). So you need to compare these costs, as well as the APRs before choosing the lender.

Interest Rate:

• The APR is variable. So it could go up or down on a monthly basis. A variation of a quarter of a percent can make a big difference in repayment. Interest is varied based on prime rate indexes posted in major publications like the Wall Street Journal every month. The prime rate is then added to what is called the margin. Your margin is based on your credit score. The better your credit rating, lower the margin.

• Lenders sometimes offer a discounted interest rate. This rate is unusually low and may last for only an introductory period, such as 6 months.

• Variable-rate plans stipulate the maximum and minimum percentage of APR chargeable.

• Variable interest rate is convertable to fixed rate during the life of the plan. Entire line or a portion of it can also be converted to a fixed-term installment loan. This conversion may be advantageous only id the interest rate moves favourably.

• Some lenders do not allow drawings when the interest rate is at the maximum agreed level.

• Interest rate is generally lower than the APR on credit cards. Let us assume that you have 10,000 in credit card debt and the average interest rate on the collection of cards is 22%. HELOC can be used to pay off your debt on the credit cards. You would save because of the interest rate.