HELOC – What is it and How is it Useful?
A Home Equity Line Of Credit, or HELOC, is a category of home equity loans in which the creditor is ready to lend a maximum amount within a particular time frame with the collateral being the borrower’s house.
HELOCs set up a line of credit for maximum borrowing rather than a fixed amount. The total amount you borrow must not exceed the credit line. Thus HELOCs are like credit cards with a fixed credit limit. During the time frame you can borrow the required sum of money as and when you need it.
The specified time frame is called a draw period. This can last for 5 to 10 years. During the draw period there is a minimum amount which has to be paid monthly. During the draw period the payment is usually made only on the interest incurred on the capital. After the draw period there comes the repayment period. This period can vary from 10 to 20 years. The borrower during this period must make payments contributing to the principle amount. Certain HELOCs require payment of the total amount at the end of the draw period in one go. The interest rate of a HELOC is usually based on an index like the prime rate. Thus the interest rate varies with changes in the market conditions.
Generally a house is the most precious asset of a borrower. Therefore the misuse of HELOCs happens very rarely. Many people use HELOCs as second mortgages. They take these home equity loans in addition to their first mortgage in order to meet some urgent expenses. But you should remember that the house can be foreclosed by the bank if you are not able to make payments on time.
Benefits of a HELOC
The major benefit of a HELOC is its flexibility. HELOCs have a variable interest rate. The interest is calculated on a day to day basis based on draws and repayments unlike regular loans where the interest is a usually a fixed number. When the drawing period ends the HELOC can be changed into a loan with a fixed rate.
HELOCs are ideal for major expenses like education, medical expenses, renovation etc. You only need to borrow and pay interest according to your needs. These expenses happen rarely and with a HELOC you can arrange the repayment schedule according to your convenience.
HELOCs are usually preferred over a regular second mortgage. In reality home equity loans are second mortgages too but the flexibility and other incentives increase the popularity of a HELOC. With a HELOC, you borrow when you need to and how much you need to. In case of a second mortgage, you will have to borrow the whole amount upfront. This can be a tricky proposition if you are not sure how your funding needs will change in the near future, or if you know that you’ll have to make another major expense soon but are not sure of the amount that you’ll need.