A HELOC, which is an acronym for Home Equity Line of Credit, is a type of revolving credit loan which is secured or collateralized by the equity in your home. By definition, equity is the difference between the (appraised) value of your property and the amount you owe on it.
A HELOC differs from a second mortgage, which typically provides a lump sum loan on the basis of a home’s equity, in that it is a flexible credit source – you can withdraw as little or as much as is needed, up to the limit of the equity. A HELOC functions more closely like a credit card, because your payments and withdrawals to the line of credit fluctuate.
Usually, the lender of record who holds your first lien will provide you with a home equity loan, subject to regular credit approval. Once approved, the lender will place another lien on the property (secondary to the original mortgage).
The line of credit amount that the lender will offer you is based on three primary factors, as well as several secondary ones:
- The appraisal amount,
- LTV ratio and
- Outstanding balance of your mortgage.
- Your income
- Your existing and potential debt
- FICO or credit score
The majority of HELOCs bear a floating or adjustable interest rate, expressed as an APR (Annual Percentage Rate), which is based on a nationally established pricing index, such as the Federal Prime Rate or U.S. Treasury Bills, plus the lender’s margin or mark-up. As the index changes, the interest rate will also change, correspondingly. By law, a variable rate HELOC must have a cap, or ceiling, which is the maximum rate your lender can charge you. Some lenders offer introductory rates, which are significantly increased after the introductory period. Lenders may also offer you the option to “fix” a portion of your HELOC, by converting the line of credit to a fixed rate instalment loan.
Restrictions to the HELOC are set by the individual lender, and may include a minimum withdrawal amount or maximum number of withdrawals per month. It’s important to understand that the lender has the right to reduce availability under the line of credit at any time, should certain circumstances arise, including but not limited re-evaluation of your credit worthiness, e.g. lowered FICO score, loss of employment, etc. or to the tightening of the lender’s credit criteria as a result of deteriorating economic conditions, or the lender’s tightening of their credit requirements.