Home equity line of credit (HELOC)

What is a home equity line of credit?

There are two types of home equity debt, viz. home equity lines of credit (also known as HELOCs) and home equity loans.  Both are sometimes referred to as second mortgages as they are secured by your home, just like your original, or primary, mortgage.  More specifically, both are secured by the available equity you have in your home.

Home equity lines of credit and home equity loans have become increasingly common since the mid-1980s as property values have soared.  The other main reasons for this surge in popularity are: attractive interest rates and tax deductibility (click IRS Publication 936 Home Mortgage Interest Deduction for more information).

A home equity line of credit gives you an approved credit limit.  You can draw your cash as needed, subject to your approved limit. You are given a check book.  You draw cash from your line of credit by writing a check or using a debit card.  In most cases, you will pay interest on the outstanding amount only.  Thus it is similar to a credit card. (By contrast, the home equity loan lender gives you the full amount of the loan in one lump sum).

The interest rate of a home equity line of credit is adjustable and is subject to change. (By contrast, the interest rate of a home equity loan remains fixed for the entire loan period).

Since the amount of cash you draw and the interest rate are variable, your monthly repayments under a home equity line of credit may vary depending on the outstanding loan amount and the interest rate in any given month.

Your loan repayment is flexible. You can make the minimum payment, or pay off the entire balance all at once, or somewhere in between.  It's all up to you. (By contrast, you repay your home equity loan by fixed monthly instalments throughout the entire loan period).

After you make a repayment, an equivalent amount of credit is again immediately available for you to draw cash on.  Therefore you can repeatedly make repayments and cash withdrawals.  (By contrast, a home equity loan does not permit re-drawing of cash. You receive the cash once only.  Thereafter you cannot borrow further from the loan, and it requires you to make monthly repayments until the loan is fully paid off).

Home equity lines of credit have lower interest rates than home equity loans.  The interest rates of equity lines of credits are variable because mortgage lenders often tie these interest rates to the current federal lending rates known as the prime lending rates or prime rates which are subject to change.

The prime rate is the interest rate charged by the federal government to major banks and other lending institutions. It is regularly adjusted by the Federal Reserve Board chairman.  It increases (or decreases) in accordance with each Fed hike (or fall).  Lenders of equity lines of credit charge you an interest rate equal to the prime rate plus or minus a marginal percentage (eg 0.25%).  You can find these prime rates published in the Wall Street Journal (or other publications), or other online sources.  Look for these sources on this site.

[back to top]