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Home Equity Line of Credit (often called HELOC, pronounced HEE-lock) is a loan in which the lender agrees to lend a maximum amount within an agreed period (called a term), where the collateral is the borrower's equity in his/her house.
A HELOC differs from a conventional home
equity loan in that the borrower is not advanced the entire sum up front, but uses the line of credit to borrow sums that total no more than the amount, similar to a credit card. At closing you are assigned a specified credit limit that you can borrow up to. During a "draw period" (typically 5 to 25 years),
HELOC funds can be borrowed and you pay back only what you use plus interest. Depending on how much you use the HELOC, you will have a minimum monthly payment requirement (often "interest only"); beyond the minimum, it is up to you how much to pay and when to pay. At the end of the draw period, you will have to pay back the full principal amount borrowed either in a lump-sum balloon payment or according to a loan amortization schedule.
Another important difference from a conventional loan: the interest rate on a HELOC is variable based on an index such as prime rate. This means that the interest rate can - and almost certainly will - change over time. Homeowners shopping for a HELOC must be aware that not all lenders calculate the margin the same way. The margin is the difference between the prime rate and the interest rate the borrower will actually pay. Lenders do not generally offer this information and it is up to the consumer to ask for it before taking a loan.
HELOC loans have become very popular in the United States in the 2000s, in part because interest paid is typically (depending on specific circumstances) deductible under federal and many state income tax laws. This effectively reduces the cost of borrowing funds. Another reason for the popularity of HELOCs is the flexibility not found in most other loans - both in terms of borrowing and repaying on a schedule determined by the borrower. Furthermore, HELOC loans' popularity growth may also stem from their having a better image than a "second mortgage," a term which can more directly imply an undesirable level of debt.
It must always be kept in mind that the underlying collateral of a home equity line of credit (HELOC) is the home. This means that failure to repay the loan or meet loan requirements may result in foreclosure.