Home Equity Line of Credit

Financial Dictionary -> Mortgages -> Home Equity Line of Credit

Home Equity Line of Credit or HELOC in its shortened form is a regular loan, but the collateral for the loan (asset which the loan is secured against incase the borrower fails to pay) is the equity in the borrower's home. To understand what a Home Equity Line of Credit is, you need to first understand what equity is.

If somebody takes out a 100% mortgage on a home worth $100,000 and has repaid $25,000 of the mortgage to the lender, then they essentially now fully own $25,000 of the property. Meaning if they sold the home the lender would get $75,000 and the owner would get $25,000. It is this money that is considered equity.

Although the owner of the home can't physically get hold of the money until the house is sold, it can still be used to secure a Home Equity Line of Credit loan.

If a home owner had $50,000 worth of equity in their home they could go to a lender and ask for a loan up to that amount. If for whatever reason they default on the loan and can't make payments the equity is used as collateral and they may be forced in to the foreclosure process, selling the home, paying off the mortgage and giving the lender the equity.

The reason it differs from a regular home equity loan or any other loan is because borrowers don't get the full amount up front, but rather use a line of credit like a credit card and are given a credit limit. Throughout the terms of the loan you can borrow money up to this limit and then it must be paid back with interest. This is done on a monthly basis.

HELOC works on a floating interest rate and is therefore similar to an adjustable rate loan, because interest rates fluctuate throughout the term and are not fixed.

Before this type of loan is taken out, regular credit checks are made. Lenders may reject a borrower if they do not have an adequate amount of equity for the loan to be worthwhile.