A Home Equity Line of Credit, or HELOC, is a type of consumer credit line offered by a bank to a homeowner for a certain term during which the homeowner can draw on the credit amount. This revolving credit line is backed by the equity in their home like a second mortgage.
A home owner usually uses this line of credit for big ticket items like home improvements, education and large medical bills. The loan will be paid back up to the credit limit with interest.
Along with looking at what you owe on the house and how much equity you have in the house, you may be eligible for a HELOC based on your credit score, credit history, and monthly income. Essentially, the bank is looking at the same factors it considers in issuing a first mortgage loan.
There are several reasons a borrower may choose a HELOC. Some of those include:
- Flexibility: You can draw from the credit line only when you need it and pay it back daily or weekly;
- Draw and Repayment Periods: The term periods during which you can draw from the credit line and when you are required to repay the funds can be negotiated with the bank. Your bank can work with you to structure the HELOC to meet your specific needs;
- Interest Rates: A HELOC often has a lower interest rate than other conventional rates and the borrower may receive a tax deduction in some cases; and
- Credit Line: Because this loan has a revolving credit line, each repayment of a withdrawal resets the credit line, allowing you to continue to borrow up to the amount of the credit line.
When looking at a HELOC for your next roof repair, consider the following disadvantages:
- Loan Terms: You will have to pay interest and you may be required to pay on the loan even during the period you are permitted to draw on the line of credit. You will also pay transaction fees and closing costs;
- Penalties: If you fail to make your payments, you risk losing your home, or having your HELOC cancelled or frozen. Like any loan, if your home value decreases, you can end up owing more than your house is worth; and
- Interest Rates: HELOC interest rates are usually variable and can change over the life of the HELOC based on what the market is doing.
While there are some features in common, a home equity loan is a different type of loan from a HELOC. Both use the equity in the home and use the home as a collateral. Both have similar loan terms, typically less than a first mortgage.
However, unlike a HELOC, a home equity loan means the borrower gets the loan as a lump payment up front and the interest rate is typically fixed. A fixed rate gives borrowers a sense of security and helps them create a disciplined plan for repayment.
In addition, payment begins on the HELOC once a withdrawal is made, whereas with a home equity loan, repayment is over a set period of time. The borrower repays the entire amount of the home equity loan, but on a HELOC, you pay what you actually withdraw as opposed to the entire amount of the credit line.
A bank can require that you apply for both at the same time, which can give you a good opportunity to weigh the pros and cons offered for those loans by the bank with which you are working.
If both loans are available to you, consider your needs carefully. Do you need the loan for a one-time, predictable payment, such as a large medical expense or credit card bill? If so, then a home equity loan might make the most sense.
However, if you are making a series of payments over a longer period, say for a long-term home improvement, and you want to repay right away each time you make a withdrawal, then a HELOC might be the way to go. The HELOC in this case might offer greater flexibility than the home equity loan.
You can apply for a Home Equity Loan of Credit by dealing directly with the bank. You should carefully consider your risks and why you need the loan before meeting with a bank representative. If for some reason you wish to challenge the loan terms or you HELOC has given rise to a legal dispute with the bank, you can hire a qualified real estate lawyer.