HELOCs: Everything you need to know

A home equity line of credit (HELOC) is a line of credit that uses your home as collateral. Here’s what you need to know.

Video Transcript

- A Home Equity Line of Credit or HELOC is a line of credit that uses your home as collateral. It's a revolving line of credit, rather than a closed end loan. Homeowners will use them to finance large purchases, such as home additions, or educational expenses, or start-up business expenses.

For many people, their home is their biggest asset, which makes it attractive as collateral free loans. Your lender will approve you for a certain credit line, which will become your credit limit. This is the maximum you may borrow at any one time.

The formula for determining the credit limit differs according to the lender. Your current debts, your credit history, and your income may also factor into how much you can qualify for. The length of time during which you can draw from your HELOC will usually be fixed.

Many plans allow you to renew this draw period. If you still owe on your plan, you may be required to pay the entire amount at the end of the draw period. Once you're approved for the HELOC, you can begin to borrow from it when you want, because the HELOC rate is variable, it changes along with the rate of the underlying indexed used.

It's a principle of good personal finance to have a plan for how to pay back your key lock. Your minimum monthly payments will likely include a mix of principal and interest. Some plans are interest only.

This means they allow payment of interest alone without any principal. If you're HELOC uses a variable interest rate. Be prepared for your monthly payments to change, unless your plan specifically allows uniform payments.

A rise of even a few percentage points in the interest rate can add hundreds of dollars what you pay in a year. Lenders will often allow a variety of payment options for you to choose from. And you can usually pay more than just the minimum. Stay financially fit friends.