What Is a HELOC?

There are some home equity lines of credit that are known as HELOCs. Unlike more traditional home equity loans, with a HELOC not all of the money is advanced to the borrower. Once the credit limit has been established, the borrower can use the HELOC as a credit card, withdrawing any desired amount as long as it does not exceed the total balance of the loan.

Usually home equity loans are not used for daily expenses and are reserved, unlike a credit card, for more important situations, such as unexpected medical expenses, education and home improvements. With a home equity line of credit, the collateral for the loan is the borrower’s equity in his or her home and the lender agrees to a term in which the full debt must be repaid.

One major difference between a HELOC and an ordinary loan is the fact that with a HELOC the interest rate is variable. Due to the fact that the determining factor in establishing the rate of interest is the prime rate index, it is inevitable that the rate will change periodically. It is also important for the borrower of a HELOC to understand that lenders calculate the difference between the prime rate and the interest rate (also known as the margin) differently.

No matter what it is called, the lending industry views a HELOC as a second mortgage. Due to the fact that some ten years ago the interest paid on a HELOC was deductible under both federal and some state laws, they became very popular. Flexible borrowing and repayment plans are also factors in the HELOC’s increased appeal.

A borrower can make any size payment as long as it is less than the total amount and at least the minimum requirement, which is usually evaluated on the basis of the rate of interest. The borrower is free to withdraw funds from a HELOC loan at any time during the draw period, which is usually between 5 and 25 years. Final repayment of the loan occurs when the amount of the loan plus the interest has been reimbursed to the lender.

The borrower’s home becomes the collateral with a home equity line of credit unlike traditional mortgages secured by non-recourse loans. Liability is a major difference between conventional loans and a HELOC as with a conventional loan the borrower is not personally liable but with a HELOC, that may not be the case. A recourse debt in the case of a foreclosure proceeding can force a borrower to be personally liable.

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