What is a Home Equity Line of Credit?
The Henssler Financial Group Position Paper

There are two types of home equity loans: a second mortgage and a home equity line of credit. A second mortgage is normally a lump sum loaned to the borrower at a fixed rate and is repaid to the lender with fixed payments. The home equity line of credit (HELC) allows the borrower to draw funds as needed and offers various repayment option at variable interest rates.

HELC is an excellent way to protect borrowing ability. In general, it is better to set up a HELC as soon as possible to use in the case of an emergency. For example, a HELC can be used to help someone get through a period of unemployment. However, if that person waits until he or she becomes unemployed, it might be impossible to get a HELC. The same holds true for retirement, therefore, it is better to have it set up before one retires. A HELC can also be used to pay for expensive items such as college, home renovations, medical bills or car purchases. However, a HELC may not be in the best interest for someone who cannot control his or her borrowing and may use it for everyday spending when it is not an emergency.

A HELC is a secured loan using the borrower's home as collateral. Interest paid on the HELC is usually income tax deductible, unlike interest on a car loan or credit card. An added bonus is that the HELC interest rate is often lower than rates on credit cards or personal loans.

The interest rate for a HELC is normally variable and is based on an index plus a margin amount such as two percentage points. Common indices are the prime rate or the U.S. Treasury Bill. Although HELC interest rates fluctuate with the index, most plans have rate ceilings and floors. Some plans also offer an initial interest rate discount for a period of time.

Generally, a line of credit amount is 75% (although up to 100% is not unusual nowadays) of the value of the home minus the mortgage balance. The homeowner may have a checkbook or a credit card to draw money from the HELC. Some HELC plans require the borrower to take an initial advance, keep a minimum amount outstanding, or to borrow a minimum amount each time he or she borrows.

Payments made to a HELC can be interest only or interest plus a small portion of principal. These two options do not lead to full repayment of principal at the end of the draw period, which is usually ten years. At the end of the draw period, the homeowner is no longer allowed to draw money from the HELC, and in some cases, will be required to repay all that he or she has borrowed. Some plans offer a repayment period that gives the borrower time to repay after the draw period has expired. Full repayment is also required if the home is sold. Some HELC plans can be renewed. Another option is to make amortized payments that will have the HELC paid off before a balloon payment has to be made.

Lastly, there are costs in setting up a HELC. The homeowner will have to pay for his or her property to be appraised. When submitting an application, a fee is charged which may or may not be refunded if the borrower is rejected for the line of credit. There may be closing costs; other fees can include attorney fees, title search, mortgage preparation and filing, title and home insurance, and taxes. A HELC may be subject to an annual maintenance fee and transaction charges. Some plans also have up-front charges and/or points.

It is important to shop around and compare several HELC plans before signing a contract. With so many options, HELC plans can vary greatly. Homeowners should compare interest rates (the index and margin amount), costs for the start-up and maintenance, and determine how they will repay the loan.

A HELC allows homeowners to protect their ability to borrow in times of need. The Henssler Financial Group believes, in many cases, it is wise to establish a HELC before it is needed. If money must be borrowed during an emergency or for large expenditures such as home improvements or financing a car, we recommend using a HELC. However, it is important for the borrower to use the HELC responsibly.