Home Equity Loans Gain Popularity Again
A home equity line of credit, also referred to as a Heloc, is a revolving line of credit that allows homeowners to borrow against the equity in their properties. It works much like a credit card, with a lender agreeing to loan a certain amount of money for a particular time period to allow homeowners to finance major purchases, such as college education, medical expenses or house renovations.
Homeowners withdraw funds as they need them until they reach their credit limit—the total amount of the Heloc. Helocs have two phases: the draw period and the repayment period.
How Helocs Work
During the draw period, which typically runs for 10 years, the homeowner can access all or part of the available credit and makes scheduled payments only on the interest. The repayments are much lower during this phase.
During the repayment period, no more money can be withdrawn, and all the borrowed money must be repaid within a specific time period—generally double the amount of time of the draw period. The repayments are much higher because they include interest as well as principal.
Repayment Options
Borrowers are required to repay with either a lump-sum balloon payment (minus the interest already paid) or via a predetermined amortization schedule. Because Helocs use the home as collateral, the amount of money that can be borrowed depends on the homeowner’s equity, which is the difference between the home’s value and the mortgage balance.
Generally, homeowners can borrow up to 85% of the value of their equity in the home. Borrowers are not required to withdraw all the Heloc funds, and there’s no interest payment on money that isn’t needed.
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Interest Rates and Fees
Helocs generally feature variable interest rates, which means the rate can change from month to month, and have few, if any closing costs. There may, however, be upfront fees, annual fees or cancellation or early-closure fees.
Their interest rates may be lower than those of other common types of loans, and their interest may be tax-deductible, but only if the money is used for a major home improvement, as defined by the IRS.
Homeowners access the funds via online transfers, checks or a credit card connected to the account. As with home equity loans and second mortgages, failure to repay the Heloc may result in foreclosure.
Eligibility and History
Lenders use a variety of guidelines, including the homeowner’s credit score and credit history, employment history and monthly income and debts, to determine eligibility for funds. In the U.S., Helocs became popular in the early 2000s, when the real estate market was booming.
However, when the housing bubble burst, in 2008-09, Helocs were one of the financial products that have been credited with contributing to the downturn because borrowers’ homes, in the blink of an eye, weren’t worth as much as the loans they contracted for.
In response to the 2008-09 real estate crisis, the country clamped down on financial-lending products. Under the 2017 Tax Cuts and Jobs Act, until 2026, the interest on Helocs can no longer be deducted from income taxes unless the money is used for a major home improvement.
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It is essential for homeowners to carefully review the terms and conditions of a Heloc before signing the agreement.
Homeowners should be aware of the risks associated with Helocs, including the possibility of foreclosure.
Homeowners can use Helocs to finance various expenses, such as college education or medical expenses.
The repayment period is generally double the amount of time of the draw period.
The repayments during the repayment period are much higher because they include interest as well as principal.
