Most potential borrowers are well aware that their home is a great source of funds when they need a loan to meet critical expenses. But many fail to comprehend the importance of understanding these kinds of loans fully before signing up for one. One common misconception pertains to the home equity line of credit (HELOC). This is often confused with a home equity loan (HEL), with many prospective borrowers using the two terms interchangeably. There are some major differences between the two that should be clearly understood before you sign up for a HELOC.HELOC vs HEL As the name suggests, a home equity line of credit is a credit line against your home. Whereas a home equity loan gives you a lump sum amount in your hands when you sign up, a HELOC does not. A bank, credit union or lending institution opens a line of credit in your name when you sign up for a HELOC with them. The upper limit of this credit line depends on the equity you have in your home. You can draw funds from this credit line as and when you need them, subject to the terms of your HELOC.Withdrawing HELOC fundsFunds from a HELOC are most commonly withdrawn using a special type of card or checks. The bank or lending institution will typically mark a specified ‘draw’ period of the total ‘loan’ time within which you can make withdrawals. During this time you are still required to make interest payments on the funds you have borrowed. If you haven’t borrowed anything yet, you can reduce your monthly outgo significantly as opposed to a regular home equity loan. However, a minimum credit line maintenance charge will be recovered irrespective of your withdrawals. Typical draw periods range from 5 to 10 years.Repaying the loanBeyond the withdrawal period, the repayment period begins. With some HELOCs, the principal has to be repaid in full at this time. The borrower may need to take a refinance loan at this point to repay the principal. Sometimes the principal repayments are phased over a pre-specified period. Usually, this period ranges between 10 to 20 years.Interest ratesAs you can withdraw in accordance with your needs during the draw period, it is impossible for the lender to predict how much balance will remain in your credit line on any particular day. The interest calculation is therefore done on a daily basis for a HELOC. Fluctuations in the market immediately affect your HELOC’s interest payable. This can be both a boon and a disadvantage depending on whether the market rates are moving up or down.The greatest advantage of a home equity line of credit is that you essentially pay interest only for the funds that you withdraw for a long time. This kind of credit line lets you keep yourself financially covered for expenses that may arise in future with minimum cost. HELOCs are often used to consolidate debts and to meet essential expenses towards medical treatment and education.
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