Home Equity Line of Credit

If you’re in need of some quick cash and own some equity in your home, one of your options is to use that equity as collateral for a line of credit.

Doing this is known as taking out a home equity line of credit, so named of course because it is a line of credit tied to your home equity.

Home equity line of credit is abbreviated HELOC (and pronounced HEE-lock as an acronym).  Home equity lines of credit can be used for many purposes; you might get one in order to pay you medical bills, to finance an education, to make improvements to your home, or even just to have some savings set aside for emergencies.

What you don’t want to do is use one for daily expenses; if you cannot afford your bills on top of your mortgage, then your lifestyle itself is unsustainable and needs adjustment.

Unlike conventional home equity loans, a home equity line of credit does not disperse all the funds to you at once.  Instead, you can withdraw against the line of credit in the same way you would use a credit card, complete with a credit limit which you cannot exceed.

The “draw period” is usually between 5 and 25 years, and you will owe back whatever you have withdrawn along with interest on that amount.  Some home equity lines of credit require that you pay a monthly interest fee throughout the duration of the draw period.  Usually you can make payments early on HELOCs without consequence. 

Something else which you should take careful note of before jumping on the opportunity to take out a home equity line of credit is that the interest rate on a home equity line of credit is adjustable based on a prime rate index.

This can be unpredictable, so it’s important to know what you’re committing to in advance.

What are some benefits of HELOCs?

The interest you pay may under some circumstances be tax deductible, which can save you money and may make a home equity line of credit more affordable than a standard credit card.

HELOCs usually are very flexible; it can be reassuring to know that you only need to borrow what you actually need, and therefore you will only owe back on that particular amount.

It can be uncomfortable (and expensive) to be roped into a huge loan when all you need are small amounts.  Some people even just get an equity line of credit to have some financial security, not because they’re planning on spending it on a regular basis.

The repayment schedules for HELOCs are usually quite flexible as well.

What is the major drawback of a home equity line of credit?

You could in theory lose your home if you fail to repay your loan, since the equity is being used as the collateral.  If you lose that equity, you could lose your home.

Another disadvantage is that home equity lenders might choose to freeze home equity lines of credit at their disclosure.  In 2008 there were a number of major banks which froze HELOCs including Bank of America, JP Morgan Chase, Washington Mutual, and Wells Fargo.

The reason for this was that the dropping values of homes was causing home equity to drop as well, and the banks no longer felt like there was adequate collateral to secure their lines of credit.  While HELOC freezes have been contested in court, judges have upheld the rights of the lenders.

A home equity line of credit can be a great way to get a little more financial security, but remember that it may not be entirely reliable, especially if your home value is plunging.

If you manage to procure one though you can enjoy the tax benefits and greater flexibility which a HELOC has to offer; if the bank does freeze your HELOC after all you can simply pursue a regular line of credit at that time.