Home Equity Line Of Credit

A home equity line of credit (HELOC) is secured by your home and can be used to do things like consolidate debt, have other debts backed by your home or give you payment flexibility.

HELOC Basics

When you take out any HELOC, there are a few commonalities:

HELOCs are based on adjustable (variable) interest rates, meaning the interest rate can change at any time, with advance notice provided. Your rate is based on a prime rate that moves up or down with financial market conditions that’s added to a margin determined by factors like your credit score, your income stability, your net worth and the purchase price or value of your home as well as any pre-existing relationship you might have with a lender. With notice, your credit limit can also change at any time.

For the portion of your home that’s secured by a HELOC, you only pay interest on the amount you use. If you had a $250,000 line of credit and had utilized $50,000, you would pay interest on the $50,000 you’ve drawn.

Types Of HELOCs

When you take out a HELOC, you can either get a standalone HELOC or a readvanceable mortgage, which is a combination of a HELOC and a fully amortizing fixed-rate mortgage.

Readvanceable Mortgage

To get a readvanceable mortgage, you’ll need a down payment of 20% or more. Your mortgage could initially be a fully amortizing fixed-term loan, but with each monthly payment, you begin to build up borrowing capacity in your HELOC. Each dollar of principal repaid is a dollar you can borrow on your HELOC. The maximum line of credit is equal to 65% of your home’s value, so on a $300,000 home, the top line of credit is $195,000.

You can use your HELOC to consolidate high-interest debts or as a fund to make home improvements or investments. However, you can also use your readvanceable mortgage HELOC as collateral for other things, like personal or car loans with separate terms.

Standalone HELOC

For maximum flexibility, you can finance your home purchase with a HELOC by making a down payment of 35% or more. This gives a ton of flexibility because you can pay down the principal at whatever pace you wish.

Depending on the terms, the HELOC may either have draw and repayment periods or have an indefinite term where you’re only required to pay interest. However, if you pay down the principal over time, you’ll pay less interest.

Benefits Of HELOCs

  • You’ll have payment flexibility.
  • You can pay back what you’ve drawn to draw it again.
  • You only pay interest on the amount drawn.

Disadvantages Of HELOCs

The main disadvantage of a HELOC is that you have to be very disciplined in order to make it work for you. Because often you only have to pay interest, the line of credit could end up costing you more over time.