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Thursday, 1 September 2016

A home equity line of credit—also known as a HELOC—can be a great personal finance tool.

There are many popular reasons for acquiring a line of credit on your existing mortgage, including consolidating high-interest credit cards or car loans, and financing a home improvement. One great benefit to a HELOC that doesn't apply to a credit card or business line of credit  is that the interest can be tax-deductible for many families.

For homeowners who have plenty of equity in their property, a HELOC can be an affordable and convenient line of credit. But how does it work?

Applying for a HELOC

To get a home equity line of credit, the property owner applies with a lender. The lender considers the property's market value and outstanding debts against the home, as well as the borrower's income, credit score, and other outstanding debt.

Once approved, the borrower pays one-time fees for the transactions that can include the loan application, loan processing, appraisal, broker, and document processing. These are commonly referred to as the upfront closing costs.

Typically, a bank may extend credit up to 80 percent of the home's value, minus the outstanding mortgage. For example, if a house appraises for $300,000, and the borrower has an outstanding $200,000 mortgage, a typical borrower may qualify for a $40,000 HELOC.

To access this money, the borrower is issued special checks, and/or a debit/credit card. Expect the lender to establish requirements for withdrawals, including a minimum on any sum you withdraw, an initial draw, and a minimum outstanding balance you must maintain.

Borrowing and paying

The borrower has a certain period of time during which they can take out the money—typically up to 20 years. This is the draw period. During the draw period, it's required that monthly payments be made, though these payments are usually interest-only.

There is another established period of time to repay the balance, which includes both the principal and any interest. A HELOC is different from a home equity loan; it's a revolving  line of credit, and the borrower does not have to use the entire sum available, but can instead borrow against it as needed—much like a credit card.

The borrower must pay off the HELOC balance in the event the property is sold, or by the pay-off date. Since the credit line is a lien against your home's mortgage, defaulting on a HELOC can put the borrower at risk of home foreclosure.

Understanding your HELOC offer

HELOCs are usually variable rate, meaning they fluctuate as prime rates go up and down. When comparing different HELOC offers, it's important to ask whether the rate offered is a discounted rate or an introductory rate—meaning it's a lower rate for a fixed period of time, typically for 3 or 6 months.

Like with any financial product, it's important to shop around to find the best deal. Do your research online, compare terms, and ask those in your network to recommend a reputable bank or broker.

 

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