Borrower’s Guide To Home Equity Line of Credit – What Is It, How It Works & More

A home equity line of credit (HELOC), is a type of home equity loan secured by your home. It provides borrowers with a revolving line of credit which can be used against other huge expenditure or to combine other high-interest loans as a consolidated debt. HELOC is a type of consumer debt available on both residential and non-residential properties. The amount of HELOC is calculated based on the specific property’s current market value.

Major criteria for getting a home equity loan include excellent credit history, a reasonable loan value and low debts by the borrower. 

In order to secure a home equity loan, you need to make sure that you have an excellent credit history. Credit Mantri, an online loan analysis platform helps you check your latest credit score for free within minutes. Use the platform to check whether you can avail of a home equity loan based on your credit score.

How does HELOC work? Before we answer that question, let us understand the types of home equity loans.

Home Equity Loans

Two categories of home equity loans

• Fixed-Rate Loans
• Revolving Home Equity Line of Credit

Fixed-Rate Loan

Under a fixed-rate loan, a single lump-sum amount is paid to the borrower. The loan amount has to be repaid as per the specified loan tenure at the applicable and agreed rate of interest. The rate of interest is fixed for the whole tenure of the loan and does not vary in accordance with market fluctuations.

Revolving Home Equity Line of Credit 

Home Equity Line of Credit (HELOC) on the other hand is a variable interest loan, which works on similar lines as that of a credit card. Under such a scheme, the borrower can also borrow part of the pre-approved loan amount which is granted by the bank. Also, the loan can come as a combined package along with a credit card. 

This option allows you to make withdrawals on the loan or with the designated cheques. The amount to be paid on a monthly basis depending on the amount borrowed and the interest rate at the time. Similar to a credit card, the borrower can again borrow the amount which they have already repaid, though HELOC is for a fixed tenure, like a fixed-rate loan.  Such an option implies that when the loan tenure ends, then the borrower has to ensure repayment of the whole outstanding amount at the time.

Working of a Home Equity Loan 

• A home equity loan, including HELOC, works just like a home loan, where the home/property acts as a security.
• The major difference is with respect to the eligible loan amount based on the market value of the house property.
• Under home loans, you are eligible for around 90% of the market value of your home whereas, under the home equity loan, you can convert the equity on your home into cash.
• The loan amount can be used for any purpose – there is no restriction on end usage.
• Repayment of home equity loan consists of both principal and interest amount.

Advantages of HELOC

• A secured loan is easily available even with a low credit score.
• Unused equity of your house can be constructively utilised.
• Can borrow only part of the credit limit as per your requirement for meeting your financial needs.
• Revolving credit facility, so it is flexible.
• The borrower can borrow the repaid loan amount.
• Helps when payment has to be done in stages as the borrower can withdraw from the line of credit as part withdrawals.
• Interest is charged only on the borrowed part of the amount.

How to calculate the loan amount in a home equity line of credit?

The home equity loan amount depends on the equity value of the house provided as security towards the loan. Home equity relates to the difference between the current value of the house and the total liabilities payable towards the home. When there is no other liability payable on your house, then equity value is the market value of the house.

The equity value of the house is a variable amount depending on the current market value of the house. So, if there are unfavourable market conditions, then this could lead to lower equity value. Such a downturn in home equity value could result in a lower home equity loan or HELOC available to you. 

Who is it for? 

HELOC is a good option for those borrowers who are looking to spread out their financial needs over time or require flexibility in equity. Such an option also allows for faster payment of the loan amount as it is normally of a smaller amount and also interest is charged only for the amount borrowed.