What is a HELOC?
A HELOC is a home equity line of credit. It is a loan, using your home as collateral, that lets you borrow up to a certain amount, rather than a set dollar amount. A HELOC (pronounced HE-lock) acts like a credit card: It has a credit limit, and you can borrow against it, pay all or part of the balance, and borrow again up to the credit limit. The interest rate varies with the prime rate.
The first 5 or 10 years of a HELOC (the period varies by lender) are known as the draw period. During the draw period, you may borrow from the HELOC and the minimum monthly payments are interest only.
After the draw period expires, the repayment period begins. Usually the repayment period last 20 years. During the repayment period, you have to pay principal and interest, so that the entire loan is repaid by the end of the period.
If you have equity in the home, have fairly good credit and have enough income to make monthly payments on what you borrow, you can apply at a mortgage lender.
The interest rate on a HELOC goes up and down with the prime rate. When the prime rate is low, the monthly payments are relatively low. When the prime rate is high, the monthly payments are relatively high.
Most often, homeowners use HELOCs to pay for home repairs and renovations. But people use HELOCs to pay for college, buy cars, pay off credit cards, make down payments on vacation homes, and myriad other reasons, wise and unwise.
HELOCs often have low interest rates compared to other available forms of debt. There are no closing costs associated with HELOCs. When the balance on the line of credit is zero, the monthly payment is zero.
If you don't repay the HELOC, the lender may foreclose on the house. If you use a HELOC to pay off credit card debt, there is the risk that you'll just charge up the credit cards again, putting yourself deeper in debt. When the draw period ends and the repayment period begins, the minimum monthly payment can jump to a hard-to-afford level.
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