HELOC (Home Equity Line Of Credit)
A
HELOC is a loan based on the equity of the borrower’s home. It allows you to
borrow against the equity you’ve already built up in your home. In its simplest
form, a HELOC works somewhat like a credit card. Money can be borrowed up to a
certain credit limit set by the lender, and the homeowner then pays back the
borrowed amounts along with interest.
Working
of the HELOC
I. Setting the Credit limit.
What
is Home equity here?
The
credit limit of a HELOC depends on a number of factors, including the
homeowner’s credit and unpaid debts, but it’s determined largely by the market
value of your home and the amount remaining on your first mortgage.
So
mainly Equity
of your home sets the credit limit
So,
Home equity= The value of your house – the unpaid debts on house (like
mortgages)
For instance, if you own a home valued at
$500,000 and still owe $200,000 on your first mortgage, then your home equity
stands at $300,000.
Banks
typically limit the amount you can borrow to no more than 85% of the appraised
value minus what you owe on your mortgage
Hence,
85% of $ 500,000 is $425,000.
Therefore
the credit limit = 425,000 – 200,000 ie $225,000
II.
Draw Period
The
line of credit you’re approved for will be available during the “draw period”. A
home equity loan comes as a lump sum of cash however HELOCs are a revolving
source of funds, much like a credit card, an you can withdraw as per your needs
upto your credit limit and during the Draw period which is generally of 10
years.
III.
Repayment Period.
That
time is then followed by a set “repayment period,” during which the borrower
can’t take out more money and instead must continue to make payments, paying
off the outstanding balance of the line of credit. It is generally upto 20
years.
Interest on a
HELOC
Because
the balance of a HELOC may change from day to day, depending on draws and
repayments, interest on a HELOC is calculated daily rather than monthly.