Home Equity Line of Credit

The home equity line of credit (HELOC) is a unique financial planning tool that allows homeowners to borrow against property value for cash. Home equity line of credit offerings are structured to allow for consumer flexibility, while also enabling banks to turn sufficient profits. Consumers must familiarize themselves with the general components and costs of the home equity line of credit application process, before taking on such a financial commitment. Proceeds from a home equity line of credit are often used to finance large purchases.

Home Equity

Home equity relates to ownership, or the difference in price between a home’s market value and its underlying mortgage. As such, home equity increases as the mortgage is paid down and real estate property values advance. Strong property values are a sign of economic growth and jobs creation that support local real estate demand. Professional appraisers are hired during the HELOC application process to estimate the market value of the real estate collateral. From there, bankers subtract the outstanding mortgage balance from the home’s appraised value, and calculate a credit limit.

HELOC Terms and Conditions

Similar to credit cards, home equity lines of credit are revolving loans. Consumers may write checks to purchase goods and services up to the credit limit. Because of these terms, a HELOC charges interest at variable rates, according to the economic environment. The HELOC, of course, requires that borrowers make monthly principal and interest payments to stay current on the loan.

Home equity lines of credit, however, feature lower interest rates than credit card loans. Again, home equity serves as collateral to secure a home equity line of credit. The real estate collateral reduces financial risks for banks, which does allow consumers to negotiate relatively low interest rates for the HELOC product. For the sake of comparison, credit cards are unsecured loans that are backed only by good faith in consumers to make timely payments.

Banking Fees

In addition to interest payments, banks earn fees as compensation for offering the HELOC product. Banks charge fees for conducting an appraisal, reviewing the loan application and servicing the account. Banks may also subject consumers to fees after each check-writing transaction that adds to your loan balance. According to The Federal Reserve Board, HELOC-related fees often cost several hundreds of dollars.

Financial Strategies

Consumers often take out home equity lines of credit in order to refinance expensive credit card debt. The HELOC may also be leveraged to purchase goods and services that create long-term wealth, such as higher-education tuition bills alongside various business equipment purchases. A home equity line of credit is more so ideal for transactions of $10,000, or more, which minimize the impact of application fees associated with the account.

Financial Risks

Avoid spending home equity line of credit funds upon consumer purchases. Using the HELOC to buy vacation packages, jewelry, and designer clothes will significantly consumer debt, at the expense of aggregate net worth. Out of control spending, of course, increases the foreclosure risks associated with the HELOC product. Again, the home equity line of credit contract grants banks the authority to foreclose on homes and auction property off to make good upon any past-due balances.