To understand the basics of home equity lines of credit, we must first ask, “what is a line of credit?” Lines of credit are what we typically think of when borrowing money comes to mind, as it simply refers to the amount of credit that’s being borrowed. For example, a credit card with a $5,000 limit is a $5,000 line of credit.
Now let’s apply this concept to home equity. A home equity line of credit (or HELOC) is a credit line that allows individuals to borrow against the equity they’ve built in their home. It’s similar to a credit card in its structure, but instead of borrowing with credit scores, a HELOC lends up to the amount of equity and uses the home as collateral.
It’s a relatively flexible way to borrow and repay money, though different lenders may have stricter requirements and terms.
How are HELOCs used?
There are several reasons why you might take out a personal line of credit based on your home’s equity. Borrowers often apply HELOC funds to improve or update the home or property, but there are a few other common life events for which homeowners use a HELOC. These events include:
- Covering the costs of an emergency
- Consolidating debts
- Paying for a child’s college education
- Starting or improving a business
- Paying for a wedding
Limits and Rates
A home equity line of credit may vary from one borrower to another when it comes to borrowing limits, interest rates, and miscellaneous terms. HELOC funding limits depend on several factors, including the home’s equity and the borrower’s creditworthiness. Additionally, some homeowners will qualify for different rates and promotions, so it’s difficult to estimate exactly what the terms of a HELOC will be for any given homeowner.
To achieve high borrowing limits and the best HELOC rates, it’s ideal to have a high credit score and significant equity built up in the property.
Pros and Cons
There’s a lot to consider when determining whether a HELOC is the right choice for a homeowner’s financial situation. Before deciding, weigh the benefits of a home equity line of credit against the potential risks that a borrower assumes.
- Relatively low-interest rates
- Possible fixed rates
- Borrowers only need to repay what they spend
- Usually higher limits than standard lines of credit
- A variable interest rate could increase
- The home is at risk if the borrower defaults
- Long, complicated application process
- Possible fees and specific drawing periods
One of the greatest benefits of home equity lies in the ability to use that equity as borrowing power. As a homeowner, increasing your home’s value stands to benefit you financially should you ever need to take out a line of credit.
If you’re considering a home equity line of credit, research your options carefully to find a lender that offers you the best credit line terms for your unique financial needs.