HELOC is an abbreviation for home equity line of credit, or also called “home equity line.” The setup is similar to a loan but by means of using a line of credit to secure against your existing home or mortgage. The difference between a HELOC and a normal loan is that with a home equity line you can advance the lenders money upfront and use it for whatever you please. A normal mortgage is paid back over time and has to be paid off in full when the mortgage contract ceases. Home owners who wonder “what is a HELOC” find this often confusing to begin with but after some time they soon get the hang of it.
Once you lender has approved your HELOC loan you can draw on it by cashing in, by check or with a special credit card. Most HELOCs are in fact second mortgages. If you look closely enough, you can see that equity stands for your net worth. So once you accumulate worth with your first mortgage, you build equity.
In recent years new home owners have started to use HELOCs as first mortgages. Doing this carries considerable risks which are outlined below.
HELOC risk 1: Draw Period
Because a home equity line of credit loan has a draw period, which can negatively affect your financial situation. If you are forced to pay back the entire balance of your HELOC at the end of the draw period you might be forced to refinance.
HELOC risk 2: APR
A HELOC APR stands for the interest rate of the loan. Contrary to standard loans interest rates, an APR or equity line rates differ and can cause massive fluctuations in your daily interest levels. On a 6 percent HELOC, interest for a day would be calculated with .06 divided by 365 or .000164, which is multiplied by the average daily balance during the month. If your balance is $200,000, the daily interest would amount to a total of $32.88.
Over a 30-day period (monthly), interest alone would amount to $986.30. As you can see, this are potential traps many are now aware of when they first ask “what is a HELOC”.
Normal mortgages amount to a lot less when we look at interest alone and can therefore be the better choice for consumers. Usually home owners choose a HELOC when they need additional funding, such as renovations, college tuition, vacations, paying off a credit card (as interest levels are higher still), or other.
The convenience of drawing and paying interest on monies needed only draws many to a HELOC loan. Depending on a lender, some of these loans can also be converted into a fixed rate loan upon drawing it. So you shouldn’t really ask what is a HELOC but more so, is a HELOC right for me?