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What is a HELOC?

Everything you need to know about a Home Equity Line of Credit

Blog - What is a HELOCA HELOC (Home Equity Line of Credit) is a type of credit available only to homeowners that offers special terms and conditions, most of which are highly desirable. To be more specific, it’s a type of loan that uses the value of the borrower’s home as collateral instead of liquid funds or other assets. It’s similar to a second mortgage concerning borrowing conditions, but it differs in that it allows a person to continually borrow smaller sums of money up to a certain limit (like a typical credit card might) instead of granting access to one large lump sum of cash.

Why Use a HELOC?

HELOCs are a good way for people who own property that they live in, rather than rent out, to leverage that property as an asset. They can be extremely useful for people who have few liquid assets but need to fund a large purchase in the near future, such as an expensive trip or home renovation project. Renovations, in particular, are a popular choice that makes intuitive sense, as you’re using your home equity to make changes that will hopefully increase the home’s value on the market—those new granite countertops are practically paying for themselves!

The limit on a HELOC is usually higher (and the interest rates more favorable) than what you might get from a consumer credit card, and you often won’t have to pay any part of the principle back for quite some time (up to 10 years in most cases). You’ll still be required to pay interest in the interim, but for obvious reasons, that payment will be lower than it would be if you were to start repayment right away. This gives you more up-front financial freedom and lets you borrow more than you normally might due to the increased monthly affordability of the loan. Sounds great, right?

Things to Watch Out For

While HELOCs certainly have their advantages, there are still a few things you should be aware of. The reason you can get such a good deal from a HELOC is that the collateral that you’ve offered increases the bank’s confidence in that loan; you’ve essentially wagered the value of your home on your ability to pay that loan back. If it turns out that you can’t do that, you may lose your home to foreclosure.

Another problem with getting a HELOC is that it may take a lot of self-restraint to keep yourself from abusing it. Lenders are more cautious about extending HELOC offers than they used to be before the 2008 financial crisis, but most homeowners can still get one, and the promise of such easy credit leads many to use it as a way of living beyond their true means. Using a HELOC should not become a habit, and nor should a HELOC be used to finance extravagances that you wouldn’t normally indulge in.

Lastly, you have to contend with the possibility of unstable payment amounts due to the variable interest rates that are common with HELOCs. Although fixed-rate HELOCs do exist, most of them present customers with an interest range instead, promising to adjust the rate depending on the fluctuations of the market. This means that while you’ll pay relatively little interest when times are good, your monthly payments could take a sudden and significant jump at any time.

A HELOC can be a great tool for a homeowner in need, but it’s important to be judicious in how you choose to use it, keeping yourself within reasonable limits and never assuming that you will be able to predict your home’s value over time with any degree of certainty. Debt is debt, no matter how long you have to repay it or how little interest you currently pay on it—think of a HELOC in its proper context and you’ll be able to get the most out of it.

 Learn more about HELOC options

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