Home equity lines - its an anatomy of revolving credit in which your domicile serves as guarantee

A Home Equity Line of Credit (HELOC) is a type of revolving credit that uses your home as collateral. Because your home is likely your largest asset, many homeowners use HELOCs only for significant expenses like education, home improvements, or medical bills, rather than for daily spending.

What is a Home Equity Line of Credit (HELOC)?

With a home equity line, you'll be approved for a specific amount of credit—your credit limit. This is the maximum amount you can borrow at any one time under the plan. Many lenders determine the credit limit by taking a percentage of your home's appraised value and subtracting the outstanding balance on your existing mortgage.

In determining your actual credit limit, the lender will also consider your ability to repay the loan by evaluating your income, debts, other financial responsibilities, and your credit history.

Many home equity plans include a specified "draw period" during which you can borrow money, often for a duration like 10 years. At the end of this period, you may be allowed to renew the credit line. If your plan doesn't allow renewals, you won't be able to borrow additional money once the draw period ends. Some plans may require payment in full of any outstanding balance at the end of the draw period. Others may allow repayment over a defined period, for example, another 10 years.

Once approved for a HELOC, you will most likely be able to borrow up to your credit limit as needed. Typically, you will use special checks to draw on your line. Under some plans, borrowers can use a credit card or other means to access the line.

What Should You Look For When Shopping for a HELOC?

If you decide to apply for a HELOC, look for the plan that best meets 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 is based on the interest rate alone and will not reflect closing costs and other fees and charges. Therefore, you'll need to compare these additional costs, as well as the APRs, among different lenders.

How Do Interest Rates and Plan Features Work?

Home equity lines of credit typically involve variable rather than fixed interest rates. The variable rate must be based on a publicly available index; the interest rate for borrowing under the home equity line changes, reflecting fluctuations in the value of that index.

Lenders sometimes offer a temporarily discounted interest rate for HELOCs—an exceptionally low rate that may last for only an introductory period, such as 6 months. Some lenders allow you to convert from a variable interest rate to a fixed rate during the life of the plan, or to convert all or a portion of your line to a fixed-term installment loan.

What Are the Costs of Establishing and Maintaining a HELOC?

Many of the costs of setting up a HELOC are similar to those you pay when you buy a home. In addition, you may be subject to certain fees during the plan phase, such as annual maintenance fees and a transaction fee every time you draw on the credit line.

You could find yourself paying hundreds of dollars to establish the plan. If you were to draw only a small amount against your credit line, those initial charges would significantly increase the cost of the funds borrowed. On the other hand, because the lender's risk is lower than for other forms of credit (as your home serves as collateral), annual percentage rates for HELOCs are generally lower than rates for other types of credit. The interest you save could offset the costs of establishing and maintaining the line. Moreover, some lenders waive some or all of the closing costs.

How Will You Repay Your Home Equity Plan?

Before entering into a plan, consider how you will pay back the money you borrow. Some plans set minimum payments that cover a portion of the principal plus accrued interest. However, the portion that goes towards principal may not be enough to repay the principal by the end of the term. Other plans may allow payment of interest only during the life of the plan, which means that you pay nothing toward the principal.

Regardless of the minimum required payment, you may choose to pay more, and many lenders offer a choice of payment options. Many consumers choose to pay down the principal on a regular basis as they do with other loans. For example, if you use your line to buy a boat, you may want to pay it off as you would a typical boat loan.

HELOCs vs. Traditional Second Mortgage Loans: Which is Right for You?

If you are considering a home equity line of credit, you might also want to consider a traditional second mortgage loan. A second mortgage provides you with a fixed amount of money owed over a fixed period. In most cases, the payment schedule calls for equal payments that will pay off the entire loan within the loan period. You might consider a second mortgage instead of a HELOC if, for example, you need a set quantity for a specific purpose, such as an addition to your home.

What Disclosures Should You Expect from Lenders?

The federal Truth in Lending Act requires lenders to disclose the important terms and costs of their HELOC plans, including the APR, various charges, payment terms, and information about any variable-rate feature. In general, neither the lender nor anyone else may charge a fee until after you have received this information. You usually get these disclosures when you receive an application form, and you will get additional disclosures before the plan is opened. If any term changes before the plan is opened, the lender must refund all fees if you decide not to enter into the plan because of the change.