A home equity line of credit is a form of revolving credit in which your home serves as collateral. You can use your home equity line of credit for major items such as education, home improvements, new cars or medical bills, rather than for day-to-day expenses.
The popularity of home equity line of credit is on the rise. In a recent LendingTree survey, 68.3 percent of respondents who had borrowed using home equity loan chose a home equity line of credit over a one-time loan in the first quarter of 2004. This is an increase from 37.5 percent in 1999.
With a home equity line of credit, you will be approved for a specific amount of credit. This amount, also known as your credit limit, is the maximum amount you can borrow at any one time while you have the line of credit.
In determining your home equity line of credit limit, lenders will consider your ability to repay by looking at your income, debts and other financial obligations, and your credit history.
Once lenders determine your creditworthiness, they will set the credit limit on a home equity line of credit by taking a percentage - as much as 125 percent - of the appraised value of your home and subtracting the balance you owe on the existing mortgage. For example:
Appraisal of home $100,000
Percentage rate x 125%
Percentage of appraised value $125,000
Less mortgage debt - $40,000
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Credit limit $85,000
Pay attention to the terms and rules
Once approved for your home equity line of credit, you typically will be able to borrow up to your credit limit whenever you want, typically using special checks. However, there may be rules about how you can use your home equity line of credit. For example, you may be required to borrow a minimum amount, such as $300, each time you draw on your credit line and to keep a minimum amount outstanding. Or you may be required to take an initial advance when you first set up your credit line.
Your home equity line of credit might feature a fixed period of time during which you can borrow money - perhaps 10 years. When this period is up, some lines allow you to renew. Others call for payment in full of any outstanding balance or permit you to repay over a fixed period - which again might be 10 years.
This information is adapted from "What You Should Know About Home Equity Lines of Credit" published by the Federal Reserve Board and the Office of Thrift Supervision.
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