What is Home Equity Line of Credit and Its Risks

A home equity line of credit is a popular option for homeowners who need a little extra cash. While some people borrow in order to make improvements to the home or property, others use the money from a home equity line of credit for vacations, to pay medical expenses or to pay their children’s college tuition. Once approved, the bank does not require the money to be spent on any one item, leaving up to the homeowner’s discretion to spend the money how they want. Some people use only a portion of the HELOC and leave the rest for a rainy day, while others invest all of it right away.

What is a Home Equity Line of Credit?

A HELOC is a special type of loan that allows a homeowner to borrow money against the value of their home. The home acts as the collateral, and if the homeowner defaults on loan payments, the bank can foreclose and claim the home. Unlike a mortgage, the money is not paid out in one lump sum. It is more like a credit card that allows you to access as much of the total loan amount as you want. You can take amounts from the principal as you need them, until you reach the credit limit.

The Application Process

The process of applying for a HELOC is similar to getting a mortgage. You can expect to fill out plenty of paperwork and answer a lot of questions as the bank determines whether or not you are a solid credit risk. During this process, the bank will send an appraiser to determine the value of your home. This will help them decide how much to lend you.

Home Equity Line of Credit Risks

However, there can be risks to taking out a HELOC for homeowners. One risk is borrowing more than the home is worth between the amount remaining on the mortgage and the amount you’ve taken from the HELOC. If you choose to sell the home, you’ll have to pay the remaining amount of the mortgage as well as the amount you’ve taken for the HELOC, which can leave you with little to no profit from the sale.

Another risk is that the home can lose value over time, especially if it isn't properly maintained over time. If the overall neighborhood goes down in desirability or real estate values in the area get lower, you can end up with a home that is worth much less in the current market than months or years before.