As homes gain in value, their owners can take out loans against the equity they've built up in their respective properties. Home equity lines of credit, or HELOCs, can be a quick, easy source of funding for those in need of cash. HELOCs can be used to pay for home repairs and improvements, or even for purposes that aren't home-related, such as education.
HELOCs vs. traditional loans
When you take out a traditional loan, you typically receive a lump-sum payment immediately after the appropriate paperwork is signed and processed. With a HELOC, however, you don't receive a lump-sum payment. Rather, your lender provides you with a line of credit from which you can access funds on an as-needed basis during the HELOC's draw period.
How a draw period works
HELOCs are divided into two periods: the draw period and the repayment period. Once you qualify for a HELOC, your loan terms will specify the terms and length of its draw period, which may last up to 20 years. Throughout your HELOC's draw period, you can draw on your available line of credit as often as you need. During this time, most borrowers are usually required to make just interest payments, not principal payments, on the money drawn.
You may be approved for a HELOC loan amount that's higher than the amount you ultimately need. You don't have to withdraw the entire amount, and once your HELOC's draw period ends, you are only obligated to repay the money you took out, not the entire approved amount. Let's say you were approved for a $10,000 HELOC but only took out $5,000 during its draw period. In this case, you're only obligated to repay that $5,000, as opposed to the total amount that was made available to you. Additionally, once your HELOC's draw period expires, you'll generally be unable to access any remaining funds, even if you only took out a portion of the total amount for which you were approved.
When the draw period of a HELOC ends, the repayment period beings. During the repayment period, you'll need to pay back any amounts you borrowed during the draw period. While HELOC repayment periods vary, borrowers are typically given 10 to 20 years to pay back their lenders.
Why use a HELOC?
Because HELOCs typically come with variable interest rates, they're not always the most cost-effective way to borrow money. Furthermore, many HELOCs impose an annual fee on borrowers, regardless of whether any money is actually drawn. The benefit of using a HELOC, however, is that it can offer immediate access to cash in emergency situations. Once you're approved for a HELOC, that money is available to you whenever you need it.