What is a Home Equity Line of Credit?
A home equity line of credit is a form of revolving credit where your home serves as collateral. Since a home is normally a consumer’s most valuable asset, many homeowners will use home equity lines of credit only for major items, such as medical bills, home improvements, or education. This being said, they generally do not use it for day to day expenses.
You will be approved for a specific amount of credit with a home equity line of credit. Many lenders set the credit limit on a home equity line by taking a percentage (say, 75%) of the home’s appraised value and subtracting from that the balance owed on the existing mortgage. For example:
How is the Credit limit for a HELOC calculated?
Appraised value of home $100,000
Percentage x 75%
Percentage of appraised value = $ 75,000
Less balance owed on mortgage – $ 40,000
Potential line of credit $ 35,000
To determine your actual credit limit, a lender will also consider your ability to repay the loan (principal and interest) by looking at your credit history, income, debts, and other financial obligations. Most HELOC plans set a fixed period of time in which you can borrow money, such as 10 years. At the end of this “draw period,” you may or may not be able to renew the line of credit. Depending on the plan, it may either call for the full outstanding balance to be paid at the end of the period, or allow a payment period over a fixed period of time.