A home equity line of credit is one of the most common loan options for people to tap into the equity they have built in their home. When someone applies and is approved for a home equity line of credit, they receive a flexible credit line.
It's like a credit card in many ways, because it's not an installment loan, like a home equity loan, which you receive in a lump sum. With an installment loan, the borrower pays set payments each month, and these monthly payment amounts remain the same. With a HELOC, homeowners have access to credit if they need it, and they then make payments on the HELOC balance as they use it.
While HELOCs function like a credit card, they do tend to have lower interest rates because the home is being used as collateral. With credit cards, there is nothing securing the debt. With that being said, the benefits of HELOCs over credit cards are dependent on the qualifications of the homeowner applying and the amount of equity they have in their home.
An Example:
If someone has a home with a market value of $500,000 and they owe a remaining $300,000 on their mortgage, they then have equity of $200,000.
Most HELOC lenders will base the amount of credit they offer on a specific percentage of the loan-to-value ratio. The percentage is often anywhere from 80 to 90 percent. If the bank in this specific example would offer a home equity line of credit for up to 90 percent, the homeowner would then have access to $180,000. This is 90 percent of the equity they have in their home.
There are reasons lenders limit the amount of equity that can be used for a home equity line of credit. It reduces their level of risk, but it also protects the homeowner.