What is a Home Equity Line of Credit (HELOC) and How Does it Work?

In our last post, we talked about ‘Home Equity Loan‘. Now let’s talk about Home Equity Line of Credit (HELOC).

A home equity line of credit is, quite simply, a type of home equity loan in which the borrower is offered a certain period where he or she could obtain loans as required up to a certain amount. Just as any other line of credit, the lender and the customer together, establish the maximum loan balance that the borrower can have access to over the prescribed period of time. While it is not so different from the HELOC, there are specific things to note. Here is what the home equity line of credit represents and how it works.

Definition of a Home Equity Line of Credit

A home equity line of credit is a type of home equity loan, where an individual (the borrower) takes a flexible loan using his or her home or property as collateral. It is regarded as flexible because rather than having to borrow one fixed amount and repay same with the required interest, the lender offers you the freedom to take the funds as you require, up to a certain point. In other words, it provides you revolving credit. It is usually seen as a second mortgage for the obvious reason that the loan is also taken on the house. It can be used to fund recurring things like a college education, medical bills, and so much more. People usually obtain the funds either through credit cards or by cashing out checks. To ensure the sustainability of the agreement, certain terms are predetermined and clear. These terms also represent the process of which the HELOC comes to be; thus, the process and how it works.

 

  • The household income

Before the lender can comfortably offer a loan of this nature to any borrower, the periodic income of the house owner has first to be assessed. While it is true that the loan is backed up by the property of the home, lenders would rather not go through the stress of enforcing their power of lien. As such, they have to assess whether or not the borrower has the capacity to pay back.

  • The credit score of the borrower

A credit score is simply the rate of creditworthiness that is ascribed to an individual. In essence, if your credit score or credit rating is high, it means you have a higher chance of not defaulting and actually paying back. If it is low, it means the opposite. Lenders naturally offer loans to those with good credit scores.

  • The value of the home

The value of the home is what sets the bar for the value or cap of the home equity line of credit. The lender gets an independent evaluator to assess the market value of the property, and it is on that basis the amount available to be borrowed is set.

  • The interest rate to be paid

The interest rate used for a home equity line of credit is usually tax deductible. It is also lower than a lot of the other loan options available. The interest rates are usually variable, and that is a limitation or advantage. The interest rate is usually based on a benchmark rate plus a margin that is established by the lender. If it goes up, you pay more, and if it goes lower, you pay less.

  • The ‘draw period’ and the cap of the loan

The draw period basically the period where you are allowed to keep collecting money until you reach a certain maximum. That maximum amount is the cap.

Related: DIFFERENCES BETWEEN PRIVATE EQUITY AND INVESTMENT BANKING

Difference between Private Equity and Investment Banking

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