What is a Home Equity Line of Credit?

B. Miller

A home equity line of credit is a type of revolving credit that may be issued to consumers who own a home and apply for the credit. The equity that exists in a home is used as the collateral against the line of credit; the equity in a home is the difference between what the home is worth, and what is still left on the mortgage or any other liens. Though some people use the terms interchangeably, a home equity line of credit, or HELOC, is not the same thing as a home equity loan.

Man climbing a rope
Man climbing a rope

A home equity loan is similar to any other loan; the entire amount of funds are disbursed up front, and repayment begins immediately. A home equity line of credit, on the other hand, is simply an open line of credit like a credit card. The borrower can use as much or as little of the line of credit as he or she desires, and it can continue to be used and paid off for as long as the borrower wants. Payments on the line of credit will include interest.

One of the benefits of a home equity line of credit is that the interest is frequently deductible on one's taxes. When one's home is used as collateral for a loan, however, it can be dangerous if one falls behind on payments, because it could lead to foreclosure. Banks have become fairly restrictive when issuing a home equity line of credit, generally requiring the borrowers to maintain a certain percentage of equity in the home after the line of credit is created. For instance, one will not be able to use one hundred percent of the equity in one's home in a line of credit. In addition, interest rates on HELOCs are variable.

Usually, a home equity line of credit will include a "draw period," which is a certain amount of years during which the line of credit may be used. At the end of the draw period, the line of credit must be paid off, and it will be closed. Generally, the borrower also has the option to pay off the line of credit and close it early without paying a penalty. A home equity line of credit may be used for a number of different things, including home improvements, education costs, or paying off high interest rate credit cards, just to name a few.

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