Topic Spin

Today my friend asked me, what is HELOC? I didn’t have a clue.

So, I looked up the term, and found out what it is:

HELOC is an abbreviation of Home Equity Line of Credit. This refers to a loan in which the lender agrees to lend a maximum amount within an agreed period. This differs from a conventional home equity loan in that the borrower is not advanced the entire sum up, but uses the line of credit to borrow sums that total no more than the amount.

A HELOC in many ways is similar to a credit card. At closing you are assigned a specified credit limit that you can borrow up to – not a check. During a “draw period” (typically 5 to 25 years), HELOC funds can be borrowed “on demand” and you pay back only what you use plus interest. Depending on how much you use the HELOC, you will have a minimum monthly payment requirement (often “interest only”); beyond the minimum, it is up to you how much to pay and when to pay. At the end of the draw period, you will have to pay back the full principal amount borrowed either in a lum-sum balloon payment or according to an loan amortization schedule.

There is one more critical difference between a conventional loan and HELOC – the interest rate on a HELOC is variable based on an index like prime rate. This means that the interest rate may change over a period – it is not constant.

HELOC loans have become very popular in the United States in recent years, in part because interest paid is typically (depending on specific circumstances) deductible under federal and many state income tax laws. This effectively reduces the cost of borrowing funds. Another reason for the popularity of HELOCs is the flexibility not found in most other loans – both in terms of borrowing “on demand” and repaying on a schedule determined by the borrower.

It must always be kept in mind that the underlying collateral of a home equity line of credit (HELOC) is the home. This means that failure to repay the loan or meet loan requirements can result in foreclosures.