Home Equity Line of Credit Definition
A home equity line of credit is a form of revolving credit, similar to a credit card, that is secured by your home, with a set maximum credit limit. The revolving line of credit offers the borrower the flexibility to borrow funds when they need them up to the total line of credit amount. Home equity lines of credit are also commonly known as HELOC loans.
The lender will typically provide the borrower with a checkbook or a credit card that is used to borrow funds against the home equity. You will be approved for a specific amount of credit, your credit limit, which is the maximum amount you can borrow at any one time while you have the plan.
How is a Home Equity Loan different from a Home Equity Loan?
Unlike a home equity loan, with a home equity line of credit, the borrower pays interest only when they use the funds. As the borrower pays back the funds they “revolve” and become available to them again for the term of the loan. For example, let’s say you have a $15,000 line of credit. You borrow $6,000, but then pay back $3,000 toward the principal. You now have $12,000 in available credit. This gives you more flexibility than a fixed-rate home equity loan because you cannot borrow further amounts of money from the standard home equity loan.
The interest rates on most home equity lines of credit vary with changes in an index rate, such as the prime rate.
Home Equity Line of Credit Limitations
Note that under some plans there may be limitations on how you can use the credit line. Because the underlying collateral of a home equity line of credit is the home, failure to repay the loan or meet loan requirements may result in foreclosure. As a result, lenders generally require that the borrower maintain a certain level of equity in the home as a condition of providing a home equity line. For example, the plan may require you to borrow a minimum amount each time you draw on the line ($200 for example) and to keep a minimum amount outstanding. Some lenders may also require you to take an initial advance when you first set up the plan.
Credit lines have a variable interest rate that fluctuates over the life of the loan. Payments will vary depending on the interest rate and how much credit you have used. Assume that you borrow $10,000 and your home equity line of credit plan calls for interest only payments. At a 10 percent interest rate, your monthly payments would be $83. If the rate rises to 15 percent, your monthly payments will increase to $125.
When the life span of a line of credit has expired, the entire outstanding balance must be paid off. This is commonly known as a balloon payment.