The Home Equity Line Of Credit (HELOC).
A home equity line of credit (or HELOC) is a line of credit that has been fully secured by the current equity in your home. HELOCS almost always have adjustable rates and usually are tied to an index such as the "prime" rate (also referred to as Wall Street Prime). The prime rate is defined as the interest rate a bank will charge its most credit-worthy borrowers, who are generally its most prominent and stable corporate clients. The HELOC rate usually is written at a fixed % over or under the prime rate and changes whenever the prime rate changes.
A typical home equity rate is prime + 1. Therefore, a home equity loan based on the current prime rate of 3.25% would have a current interest rate of 4.25%. Most HELOCS provide for payment of interest only for a period of time, but a borrower may pay principal at any time. As the loan balance decreases with principal payments, the amount of interest required to be paid is also reduced.
A HELOC offers control over your finances and several other benefits:
- The interest may be tax-deductible interest
- Interest rates are typically (though not always) lower than rates on other types of loans, especially the rates on fixed rate second mortgage loans
- Borrowers may pay down principal then draw on principal at any time during the draw period giving them continuous access to the funds.
Many people use HELOC loans for these purposes:
- Home improvements
- Student tuition
- Payment of higher rate credit card balances
- Other unexpected expenses
Home Equity Loan Draw Period and Payback Period
In most circumstances, interest only is paid during the draw period. Once the draw period is over, the loan will amortize over a previously specified period of time.
The typical draw and payback terms cover a 10 year draw period and a 20 year payback (or amortization) period. During the draw period, the balance can be paid down as much or as often as the borrower wishes. During the payback period, principal and interest are due on a monthly basis. Customarily, the HELOC rate and payment amount will adjust as the prime rate adjusts, both during the draw and the payback periods.
Often, home equity lines are secured as a second mortgage loan, but they may be written as a first mortgage as well. Self employed people who make most of their money during a certain time of year also occasionally use home equity lines for a cash flow management tool.