A Home Equity Line of Credit is a loan that is set up to have a fluctuating credit line of some maximum amount, instead of a fixed amount.  It is similar to a credit card in that you have a predetermined limit available to you, but you do not need to use all the funds at once.

When you get a typical mortgage all of the loan proceeds are disbursed at closing.  For example, if you take out a second mortgage for $40,000, then $40,000 is paid out to you at closing.  If you get a Home Equity Line of Credit for $40,000 you can take any amount up to $40,000 at closing and draw additional funds in the future by writing a check or using a special credit card issued by the bank.

Home Equity Line of Credits are useful for funding your intermittent needs, such as paying college tuition, paying high interest credit cards to lower monthly expenses, completing home improvement projects or taking a vacation.  You only draw what you need and only make payments based on what you draw.

Upfront costs on Home Equity Line of Credits are relatively low.  If you where to take a standard mortgage of $130,000 you would have settlement charges ranging from $2,000 to $5,000.  On a Home Equity Line of Credit of the same amount costs will rarely exceed $500 and the costs can usually be paid from the proceeds of the initial draw.

Typically, Home Equity Line of Credits are second mortgages, but the number of first mortgage Home Equity Line of Credits is rising.  In recent years people have been obtaining Home Equity Line of Credits to refinance their first mortgage.  Because the balance of a Home Equity Line of Credit may change on a daily basis, depending on payments and draws made by the borrower, interest on a Home Equity Line of Credit is computed daily instead of monthly.  For example, on a standard mortgage at 9% interest for the month is .09 divided by 12 or .0075, multiplied by the loan balance at the end of the proceeding month.  On a 9% Home Equity Line of Credit interest for a single day is .09 divided by 365 or .000247 which is multiplied by the months average daily balance.  This will result in a slightly higher interest payment when the maximum amount has been drawn from the Home Equity Line of Credit.

Home Equity Line of Credits have a time limit which the borrower can use the line.  This is called the draw period.  The repayment period refers to the amount of time in which the loan must be repaid.  Draw periods typically range from 5 to 10 years, and repayment periods typically last 10 to 20 years.  During the repayment period the borrower must make monthly principle payments equal to the draw amount divided by the number of months left in the repayment period.

The largest disadvantage of the Home Equity Line of Credit is the borrowers exposure to changes in the interest rate.  All Home Equity Line of Credits are adjustable rate mortgages (ARMs), but changes in the market effect them much quicker than standard ARMs.  Now, some Home Equity Line of Credits are convertible into fixed-rate loans at the time of a drawing.  This is a useful planning feature for borrowers that draw a large sum at one time.

If you are interested in obtaining more information on Home Equity Line of Credits please Contact Us. One of our mortgage specialists will be happy to assist you. 

Article written by David M Farrands