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Home Equity Line of Credit
A Home Equity Line of Credit
(often called HELOC, pronounced HEE-lock) is a loan in which
the lender agrees to lend a maximum amount within an agreed
period (called a term), where the collateral is the borrower's
equity in his/her house.
A HELOC differs from a conventional home equity loan in
that the borrower is not advanced the entire sum up front,
but uses the line of credit to borrow sums that total no
more than the amount, similar to a credit card. At closing
you are assigned a specified credit limit that you can borrow
up to. During a "draw period" (typically 5 to 25 years),
HELOC funds can be borrowed "on demand" and you pay back
only what you use plus interest. Depending on how much you
use the HELOC, you will have a minimum monthly payment requirement
(often "interest only"); beyond the minimum, it is up to
you how much to pay and when to pay. At the end of the draw
period, you will have to pay back the full principal amount
borrowed either in a lump-sum balloon payment or according
to a loan amortization schedule.
Another important difference from a conventional loan: the
interest rate on a HELOC is variable based on an index such
as prime rate. This means that the interest rate can - and
almost certainly will - change over time.
HELOC loans have become very popular in the United States
in 2000s, in part because interest paid is typically (depending
on specific circumstances) deductible under federal and
many state income tax laws. This effectively reduces the
cost of borrowing funds. Another reason for the popularity
of HELOCs is the flexibility not found in most other loans
- both in terms of borrowing "on demand" and repaying on
a schedule determined by the borrower. Furthermore, HELOC
loans' popularity growth may also stem from their having
a better image than a "second mortgage," a term which can
more directly imply an undesirable level of debt.
It must always be kept in mind that the underlying collateral
of a home equity line of credit (HELOC) is the home. This
means that failure to repay the loan or meet loan requirements
may result in foreclosure.
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