A homeequityline of credit, or HELOC, is a loan in which the lender agrees to lend a maximum amount within an agreed period, where the collateral is the borrower's equity in their house. Because a home often is a consumer's most valuable asset, many homeowners use home equity credit lines only for major items, such as education, home improvements, or medical bills, and choose not to use them for day-to-day expenses. HELOC abuse is often cited as one cause of the subprime mortgage crisis.
Differences from conventional loans
A HELOC differs from a conventional home equity loan in that the borrower is not advanced the entire sum up front, but uses a line of credit to borrow sums that total no more than the credit limit, similar to a credit card. HELOC funds can be borrowed during the "draw period". Repayment is of the amount drawn amount plus interest. A HELOC may have a minimum monthly payment requirement ; however, the debtor may make a repayment of any amount ranging from the minimum payment to the drawn amount plus interest. The full drawn amount plus interest is due at the end of the draw period, either as a lump-sum balloon payment or according to a loan amortization schedule. Another important difference from a conventional home equity loan is that the interest rate on a HELOC is usually variable, but not always. The interest rate is generally based on an index, such as the prime rate. This means that the interest rate can change over time. Homeowners shopping for a HELOC must be aware that not all lenders calculate the margin the same way. The margin is the difference between the prime rate and the interest rate the borrower will actually pay. HELOC loans became very popular in the United States in the early 2000s, in part because banks were using ad campaigns to encourage customers to take out home loans, and because interest paid was typically deductible under federal and many state income tax laws. However, after 2017 interest on a HELOC is no longer deductible unless the loan is used for substantial home improvement. This effectively reduced the cost of borrowing funds and offered an attractive tax incentive over traditional methods of borrowing such as credit cards. Another reason for the popularity of HELOCs is their flexibility, both in terms of borrowing and repaying on a schedule determined by the borrower. Furthermore, HELOC loans' popularity may also stem from their having a better image than a "second mortgage", a term which can more directly imply an undesirable level of debt. However, within the lending industry itself, a HELOC is categorized as a second mortgage. Because the underlying collateral of a home equity line of credit is the home, failure to repay the loan or meet loan requirements may result in foreclosure. As a result, lenders generally require that the borrower maintain a certain level of equity in the home as a condition of providing a home equity line.
