A home equity line of credit is a special type of revolving credit where your home serves as the collateral. This particular line of credit is that which is most often used by consumers because the home is often the individual’s highest valued asset.
Due to the fact that the home is placed as the collateral on the line of credit, most consumers use the line of credit for items that are considered to be major life expenses. Examples of these items include home improvements, medical expenses, and educational pursuits.
In most instances, home equity credit lines are not used for small expenditures or the expenses that are commonly incurred on a day-to-day basis. In this brief guide, you will learn a few important facts about a home equity line of credit.
Home Equity Line of Credit
Determining the Line of Credit
When you apply for a home equity line of credit, you will be provided with a specific amount of credit. Lenders often differ on how they determine how much they will provide you. Generally speaking, though, most will set the credit limit on a home by taking a percentage of the home’s value and subtracting that amount from the amount that exists on the current mortgage.
Let’s say that the appraised value of your home is $100,000 and the percentage that your lender uses is 75%. That percentage of the value would total $75,000. Let’s then say that the balance remaining on your mortgage is $40,000. The potential amount of credit that you would receive on a home equity line of credit would be $35,000.
$100,000 x 75% = $75,000 – $40,000 = $35,000
When the line of credit is determined by your lender, your ability to actually repay the line of credit (both the principal and the interest) will also be considered. The lender will evaluate your income, review your debts, look at your credit history, and consider your financial obligations. While $35,000 (using the previously mentioned example) may be your potential line of credit, when a lender determines your ability to repay the money, this figure may be reduced. It is not to be punitive, but, rather, to ensure that you are not set up for failure.
The Draw Period
When considering a home equity line of credit, it is important to understand the concept of the “draw period”. Essentially, these plans often set a time period when you are able to borrow the money or use the credit. Let’s say that the lender sets this to 10 years. At the end of this time, you will usually be allowed to renew the credit line. If the plan does not include a renewal, you will not be able to renew the plan or borrow money from the home equity line of credit after the draw period.
Additionally, it could be that you will be required to pay any remaining balance at the end of the draw period. Now that you know what a home equity line of credit is, how your credit line is determined, and what a draw period is, be sure to come back next week to learn what you should consider when shopping for a plan.
Until then, if you have any questions, please, feel free to contact Somerville National Bank at one of our 6 Locations