Definition of "Home Equity Line of Credit (HELOC)"
To define a home equity line of credit, we can also take a look at how credit cards work. Similarly to credit cards, home equity lines of credit are sources of funds that can be accessed and are at the homeowner’s disposal.
What is a home equity line of credit?
Compared with home equity loans, it is easy to see that home equity lines of credit either have fewer closing costs or don’t have any. Homeowners can access home equity loans through various platforms: online transfers, through a credit card that is linked to the homeowner’s account, or through written check. Their interest rates are also flexible, although there are banks that impose a fixed rate for a specific number of years.
The interest rate is often calculated daily as the balance of the account can change daily. The way home equity lines of credit work allow the borrower to be relatively flexible with payments. It’s also important to know that HELOCs have advantages and disadvantages, and we’ll explain how they work for homeowners.
Draw Period and Repayment Period
Home equity lines of credit usually incorporate two periods. These periods cover the timeline of your home equity line of credit.
Draw periods are usually five to 10 years, during which the borrower is only required to pay interest. During this time, the borrower has access to the funds and can spend it how they choose. Additionally, the borrower can pay extra, more than the interest requires, money that would go to the principal, and diminish the repayment period’s payments.
Repayment Periods are usually 10 to 20 years, during which the borrower must make payments on the principal equal to the balance at the end of the draw period. These payments are split between the months that cover the Repayment Period. The reason why HELOCs allow higher payments in the Draw Period is to help the borrower with the repayments as the value of the interest rate plus the borrowed money can be substantial.
The difference between the draw period and repayment period regarding the payments can sometimes double as the borrower doesn’t only pay interests anymore. Paying some of the value borrowed during the Draw period can help diminish that gap and make the difference less shocking.
HELOC borrowers may encounter hardship with the difference between the two periods. They can be unprepared for the shock and the big difference, and, unfortunately, failure to meet the repayments can lead to defaulting on the HELOC and losing their homes.
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