What is a HELOC?

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Author: Christian Rios

Article source: http://www.articlesfactory.com/. Used with author's permission.

This article provides basic information about how a HELOC (Home Equity Line of Credit) works.

What exactly is a HELOC? Let's first define what those letters stand for: Home Equity Line of Credit or Home Equity Line. This type of loan allows the borrower to write checks or pull cash out against their home equity up to a certain, predetermined amount.

By comparison, a conventional loan is paid back over the loan term, while the borrowed money is either given to the borrower or used to payoff a previous mortgage, credit cards, student loans, etc. A HELOC allows the borrower to withdraw funds up to a predetermined amount and the monthly payments will be based on the actual money withdrawn. For example, if you acquired a $50,000 HELOC on your home, you would be able to write checks against that credit line up to $50,000, at which point your HELOC would cease to allow you to draw against it. Your monthly payments would be based on the amount withdrawn from the credit line. If you only borrowed $20,000, then your monthly payment would be based on that amount.

A HELOC is often likened to a giant credit card with your home used as collateral. They are most often a second mortgage on a home, and are best used for temporary needs such as short-term financial help for your small business, paying for college, paying off credit cards, or even for home remodeling. A HELOC is also nice to have for a "reserve fund" in case of unforeseen emergencies.

Most HELOC's have what is called a "draw period". This time frame - which is usually from 4 to 10 years, is when you can get cash against the credit line. During the draw period, the borrower typically only has to make interest-only payments on the loan. After the draw period ends, the loan goes into a "repayment period". This time-frame can last 10 to 20 years. The monthly payment during the repayment period will reflect the balance at the end of the draw period along with the current interest rate. However, some HELOC's require the borrower to pay the entire loan in full at the end of the draw period. If you are considering a HELOC, I highly recommend you speak with your loan broker and have him or her clearly define the draw period and the repayment period for the loan you are applying for.

Lending fees are typically much lower on a HELOC than a conventional loan. A HELOC will cost anywhere from .5% to 1% of the credit line, and sometimes those fees will be waived altogether by your lender. On the other hand, a conventional loan will typically cost anywhere from 2% to 5% of the total loan amount.

A Home Equity Line of Credit is an ARM, or an Adjustable Rate Mortgage. This means your HELOC interest rate will be subject to the rise and fall of the current prime rate. Any changes in the prime rate can adversely affect your HELOC the very next month. And most HELOCs (but not all) do not have a fixed introductory rate, meaning the initial interest rate is not guaranteed (locked in) for a specific number of months. If your HELOC does not have a guaranteed, fixed initial interest rate and the prime rate moves 2% against you, then your HELOC's interest rate will go up 2% the very next month. HELOCs - unlike conventional mortgages, do not have rate-increase caps. Essentially, they could increase to their maximum interest rate in a very short period of time, which is 18% for most states. This high interest rate is why most loan brokers refer to them as giant credit cards.

If you are considering a Home Equity Line of Credit, make sure you determine the following before you sign loan documents:

Draw period - find out exactly how long you will be able to draw against the loan.

Repayment period - find out exactly when the repayment period begins and how long it will last.

Guaranteed Introductory Rate - do you have a guaranteed interest rate? If so, how long will this rate last?

A Home Equity Line of Credit is much riskier than a conventional loan. However, for the right situation, HELOCs do have their uses.

Source: Free Articles from ArticlesFactory.com

Christian Rios is an x-loan officer for a major, US direct lender. He now specializes in educating home owners about available home loans. You can learn more about HELOCs at this site: heloc mortgages. To learn more about traditional home refinancing, please visit: california refinance home equity loan California mortgage. And if you or someone you know is interested in a reverse mortgage, you can learn more about them here: riverside California reverse mortgage.