Question: "How does a home equity line of credit work?"
– C. Fairbanks, Oro Valley
Answer: A home equity line of credit (HELOC) is a revolving line of credit collateralized, or promised as security for repayment, by a home that you own.
This credit product, offered by most banks, savings and loans, and credit unions, includes features such as:
• During a revolving or drawdown phase, the account holder can take advances from the line or pay down the principal balance of the credit line. The drawdown phase usually lasts between one and 10 years, during which interest only is payable monthly. The interest on the account is based upon the actual amount outstanding during the month, and not on the line amount.
• A loan repayment phase, including principal and interest, usually begins at the end of the drawdown phase and amortizes, or reduces with regular payments, the outstanding balance over 10-30 years.
• A variable interest rate can change no more than once a month, even if prime rate adjusts more than once in a calendar month. A variable interest rate tied to the national prime rate is published every day in the Wall Street Journal.
• Easy access to the credit line is usually available through account checks or with a debit card. Closing costs and/or a pre-payment penalty fee plus an annual account maintenance fee may be attached to the account.
• Since this type of account involves real estate, it usually requires an appraisal and a property title policy; those costs sometimes are paid by the lender. However, if the borrower closes the line within two to three years, the pre-payment penalty is often what the lender paid to initiate and institute the account. If the borrower paid the closing costs, then there's usually no pre-payment penalty.
A home equity credit line is a useful product because you only pay interest on the loan balance during the drawdown phase. In addition, the interest paid is sometimes tax-deductible, and the interest rate is usually lower than credit card interest rates.
This credit line can be a valuable financial tool for homeowners if responsibly utilized. However, you could lose your home if you default on this type of loan. Therefore, use it wisely.
Fred Dawson, Jr. is the executive vice president and chief credit officer at Commerce Bank of Arizona, a locally owned community bank specializing in serving residents and small to mid-size businesses in Southern Arizona. Fred may be contacted at (520) 325-5200, or firstname.lastname@example.org.
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