Home Equity Line of Credit

How a Home Equity Line of Credit Works

Home equity credit works much like a credit card. It's set up like a revolving account, allowing you to borrow from the equity that has built up in your home.

As home values increase across the nation, home equity lines of credit have become very popular. Many homeowners are using this type of credit to finance large expenditures, such as home improvements, tuition costs, debt consolidation, and medical bills.

Though a line of credit borrows from your home's equity just like a home equity loan, there is one major difference. Unlike a home equity loan that provides a lump sum of money, a line of credit works more like a credit card. You are approved for a specific amount of money and can borrow over and over again until you meet the limit. As you make payments on the principal, the credit revolves allowing you to use it again and again.

For example, say you have a $10,000 line of credit. You borrow $5,000 and repay $3,000. You will then have $7,000 worth of credit that you can continue borrowing from.

In most cases, lenders set a time limit or a fixed period in which you can borrow money. This limit can vary between one year and 15 years. When the period expires, you can renew the line of credit or apply for a new one, providing you still have equity available in your home.

Rates on a Home Equity Line of Credit

Rates on a home equity line are typically variable rather than fixed. This means that the interest rate fluctuates over the life of your credit line.

The payments that you make on a home equity line of credit also fluctuate depending on how much you have borrowed and what the current interest rate is.

To make lines of credit more attractive to borrowers, lenders often offer a temporarily discounted rate that lasts for a specific period of time, usually six months to a year. That rate will then rise to match up with the value of the index that is being used, plus a margin of about two percentage points. It is a good idea to ask the lender which index is used and how often the value of the index changes, as the cost of borrowing will be greatly affected by this information.

You may also want to ask about the possibility of converting from a variable rate to a fixed rate. Some lenders allow this. Others may allow you to convert a portion of the money you borrowed from your home equity line of credit to a fixed rate installment loan.

Getting Approved

Getting approved for a home equity line of credit is relatively easy, especially if you have a large amount of equity built up in your home. However, there are a few things you can do prior to applying to increase your chances of getting a fair interest rate:

• Pull a copy of your credit report. Check for mistakes and negative information. Do your best to get these items cleared up prior to applying.
• Find the right lender. If you have bad credit, you may be better off working with a lender who specializes in sub-prime lending.
• Approval hinges on the amount of equity that you have. Before your home is appraised, get it in the best shape possible through repairs and improvements.