HELOC is an acronym for “home equity line of credit” and it’s a close relative of the home equity loan or “second mortgage,” wherein a bank agrees to loan you money using the equity in your home as collateral. Equity is how much of your house you actually own, a number that can be arrived at by subtracting how much you owe the bank from the current value of the house. A home equity loan is pretty simple: the bank loans you a set amount of money at a set rate for a set period, generally shorter than the term of your mortgage, and all’s great, unless of course you default, in which case the lender can take your house.
HELOCs are a fair bit more complicated. They work more like credit cards than mortgages, in that the lender will agree to allow you to draw on a credit line of a specific amount based on how much home equity you have. Using either lender-supplied checks or a card that works just like an ATM or credit card, you can spend the HELOC whenever and however you want, for a specific period of time, generally between five and ten years. This is called the draw period. During the draw period, you’ll only be required to make payments on the interest. Unlike a home equity loan, a HELOC’s interest will vary according to the movement of the prime rate. After that initial draw term, the lender will have the option of renewing the HELOC for another draw period, or else transition into the repayment period, typically between 10 and 20 years, during which all unpaid principal and interest must be paid back. A warning for those who think they’ll be able to postpone repayment indefinitely; lenders will generally want to start getting their money back right away if the financial circumstances of the borrower change for the worse.