What Is A Home Equity Line Of Credit (HELOC)?
A home equity line of credit (HELOC) acts a bit like a credit card, only your credit limit with a HELOC is based on the equity that you’ve built in your home.
Equity is the difference between what your home is worth and what you owe on your mortgage. If you owe $200,000 on your mortgage and your home is worth $350,000, you have $150,000 in equity. You’ll then be able to apply for a HELOC for a portion of this equity. If you have $150,000 in equity, you might qualify for a HELOC with a credit limit of $130,000.
You can then borrow up to that amount and use the money for whatever you like, from home renovations to paying off high-interest-rate credit card debt or covering a portion of your child’s college tuition.
The best use of the funds from a HELOC is for home improvements or renovations. If you spend your HELOC dollars on improvements that boost the value of your home, you can deduct from your income taxes the interest that you pay on your line of credit. You can also deduct the interest you pay on a HELOC if you use the funds to buy or build a home. If you use your HELOC for any other use, including paying off credit card debt, funding a vacation or covering your child’s college tuition, you can’t deduct the interest.
HELOCs come with two phases, the draw period and the repayment period. During the draw period, which usually lasts from 5 to 10 years, you can borrow against your HELOC’s credit limit. Say you have a HELOC with a credit limit of $100,000. One year, you might borrow $25,000 to build a primary bathroom. Two years later, you might borrow $30,000 to renovate your home’s kitchen.
During the draw period, you are only required to pay interest on what you’ve borrowed. In the above example, you’d pay interest on $55,000, the money you borrowed for your bathroom and kitchen projects. You can also pay back some or all of the money you’ve borrowed during the draw period, which would reduce what you owe when it’s over.
Once your HELOC enters its repayment period, you can no longer borrow against it. Instead, you must repay what you borrowed, with interest. It varies by lender, but you’ll often have 20 years to pay back what you’ve borrowed. If your credit limit was $100,000 and you borrowed $80,000, you’ll only pay back that $80,000 amount, plus interest, during your repayment period.
HELOC Vs. Home Equity Loan
It’s easy to get them confused, but a HELOC is not the same as a home equity loan.
The main difference between a HELOC and a home equity loan is how you get your money. With a home equity loan, you receive your funds in a single lump sum. You then pay this amount back with regular monthly payments with interest.
Say you have $80,000 in equity in your home. You might take out a home equity loan for $60,000. You’ll receive that $60,000 in one payment, and you can spend that money however you’d like. You’d then make regular monthly payments until that sum is paid back, usually over a period ranging from five to 30 years.