Home equity line of credit (HELOC) functions more like a typical variable rate credit card.
You are allowed to borrow up a specific amount of money - your credit limit - and you may tap the credit anytime you want, usually by making a check.
Typically, the lender calculates the sum of your credit line based on the percentage (generally between seventy-five and eighty percent) of your house's appraised value and then subtracts it with the outstanding balance of your current mortgage.
Your lender also evaluates your credit score and/or credit history and reviews your overall financial condition.
If you have to repay the home equity loan by paying fixed monthly payment that include both principal and interest, then with a HELOC you generally have the option to make a payment only on the interest each month or paying principal and interest on the debt.
If you choose to make interest-only payment, the payment amount depends on the current interest rate and also the amount of your total credit limit.
Say, if your HELOC is $30,000 but you have borrowed only $10,000, the interest is calculated only on the $10,000.
The actual problem with paying only the interest is that the more time the principal is left unpaid, the more the HELOC costs you, particularly if the interest rate begins to rise.
Also, if the HELOC expires after a specific number of years and there are no provisions for renewing it, your lender will probably ask you to pay the entire amount you still owe based on a lump sum payment, also called as a balloon payment and if you can't afford to pay then you may lose your property.
Federal law necessitates lenders to cap the rate of interest they charge on your HELOC.
Before you sign the HELOC-related paperwork, you should get clear on the interest rate cap.
Also, ask if you can convert your HELOC for a fixed interest rate.