How Do HELOC Loans Work?

A home-equity line of credit or HELOC is a type of lending product that you can use to borrow against the equity in your house. While it is similar to a home-equity loan, it differs in the level of flexibility that it provides. Home-equity lines of credit give you a way to access your home-equity at your discretion.

HELOC Basics

A home-equity line of credit is a tool that works like a credit card except that the credit relies on the amount of equity you have in your home. Once you take out the HELOC, you can access the home-equity at any point. By comparison, with a home-equity loan, you get all of the money from the equity on the front end and then have to start repaying it immediately. A HELOC allows you to open the line and then borrow the money when you need it.

Phases of HELOC

The HELOC is typically broken up into two phases. The initial phase of the HELOC is the draw period. During this phase of the home-equity line of credit, you can take money out of your line of credit up to the credit limit. After the draw period, the repayment period begins. During that time, you can no longer access the line of credit and you have to start repaying the amount that you borrowed.

Interest Rates

When you take out a home-equity line of credit, you gain flexibility, but it comes at a price. The interest rates that are associated with home-equity lines of credit are typically higher than what you could get with a fixed home equity loan. In addition to being higher, they are also usually variable rates. This means that the rates fluctuate, depending on the interest rates available in the lending market. This could make your payment more than you can afford if interest rates increase.

Considerations

When you open a home-equity line of credit, you must use self-discipline to avoid getting into financial trouble. Once the line is open, you can easily access it with a checkbook or a debit card, in most cases. If you do not have money for something, it is very easy to pay using the line of credit. This could eventually lead to a large amount of debt that you cannot afford to pay back. Only use the line of credit for important expenses that you cannot avoid.

References

About the Author

Luke Arthur has been writing professionally since 2004 on a number of different subjects. In addition to writing informative articles, he published a book, "Modern Day Parables," in 2008. Arthur holds a Bachelor of Science in business from Missouri State University.