When you need to borrow money against your home, one option you might consider is a HELOC or Home Equity Line of Credit. With this flexible type of finance, the bank sets up a credit account that you can access at will like a credit card facility, up to the pre-determined limit. The limit depends on how much equity you have in your home, which in banking jargon is known as the loan-to-value ratio or LTV.
LTV HELOC is an acronym, standing for Loan to Value Home Equity Line of Credit. It works like a credit card, with the homeowner drawing cash at will from a credit account up to the pre-determined limit. That limit is based on the home's loan-to-value, or how much equity you have in your home – hence the phrase LTV HELOC.
Loan to Value (LTV)
Loan to value is the percentage of equity value a bank will lend, using your home as collateral. Banks often lend as much as 125 percent LTV to home owners with good credit. Simply put, if the equity in your home is $100,000, a bank might lend you $125,000, using your home as collateral.
Home Equity Line of Credit (HELOC)
Banks offer two primary home equity lending vehicles:
1) Traditional Home Equity Loan: In this scenario the homeowner borrows a fixed amount, for a specific purpose, and agrees to payment terms over a fixed period of time. This is also known as a second mortgage. A homeowner may take this type of loan to consolidate debt, purchase a vehicle, start a business or fund higher education. The interest paid on this type of loan is frequently tax deductible, making it an attractive option for many borrowers.
2) Home Equity Line of Credit: The HELOC was developed for borrowers wanting more flexibility than a traditional home equity loan typically affords. In this scenario, the bank sets up a credit account, with a limit, that the homeowner can access at will. Typically these credit accounts are accessed by check or with a credit card. Repayment terms are flexible as well, utilizing variable interest rates and monthly minimum payback amounts. Like the traditional home equity loan, the interest paid on a HELOC is frequently tax deductible.
Balancing Risks and Rewards
Make no mistake: home equity loans and lines of credit are second mortgages, and your home is on the line as collateral. If you are unable to make the agreed upon payments, you could lose your home. You need to assess carefully whether the money you are taking out of your home is worth that very real risk.
If you should should need to file bankruptcy, a primary residence with one mortgage is frequently protected under the law. That protection, however, may not extend to subsequent mortgages and liens.
Making a HELOC Work for You
Now that you have heard the warnings, there are circumstances where a HELOC or a traditional home equity loan may make sense. These vehicles can relieve financial stress, enabling you to: 1) Avoid bankruptcy by using your equity to consolidate debt. 2) Pay medical expenses. 3) Invest in yourself, through launching a business or obtaining higher education. And 4) Safeguard your credit rating. As with all things, keep your eyes open and balance risks and rewards carefully.
Karen Y. Larkin was a contributing author to the critically acclaimed "Bodywise Woman," published in 1996. She has also written extensively for "The Melpomene Journal for Women's Health," U.S. Bank, and Love to Know. She hold a bachelor's degree in English.