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How Does a Home Equity Line of Credit Work?

Your home is typically one of your greatest financial assets. You can leverage the equity in your home for all types of financial needs, including debt consolidation, home improvement projects, and to pay for major life events such as vacations and weddings.

You may have heard of a home equity line of credit before but still have questions such as how a home equity line of credit works and the pros and cons of taking out this type of financing.

Keep reading to learn more about how they work, the benefits and potential drawbacks of a home equity line of credit, how to shop for the best home equity line of credit, and how to manage one when you have it.

UCCU Home Equity Options

What is a Home Equity Line of Credit?

A home equity line of credit is essentially a revolving source of credit that offers you access to funds in exchange for using your home as collateral. As a secured financial product, a home equity line of credit guarantees to the lender that the funds will be paid back – one way or another.

You may also see a home equity line of credit referred to as a second mortgage or a home equity loan. However, a home equity line of credit is different from a home equity loan in that home equity loans provide one lump sum, and home equity lines of credit offer borrowers an open line of credit.

How Does a Home Equity Line of Credit Work?

A home equity line of credit allows consumers to access their line of credit during a fixed period known as the draw period. The average draw period is typically somewhere around ten years. You will have the ability to make repeated withdrawals from your line of credit during this time as you pay down your balance.

Pros & Cons of a Home Equity Line of Credit

There are several benefits to taking out a home equity line of credit with your home as collateral, but there are a few things to be aware of. Keep the following points in mind when deciding whether or not a home equity line of credit is right for you:

Home Equity Line of Credit Pros

  • Leverages the equity in your home
  • Offers access to a flexible line of credit without stipulations on the use of funds
  • The interest paid might be tax-deductible if the funds are used to renovate or improve your home
  • Homeowners are not locked into borrowing a specific amount
  • No closing cost

Home Equity Line of Credit Cons

  • May be subject to high interest rates and hidden fees
  • Consumers may be unprepared for a possible balloon payment some lenders require at the end of the draw period
  • There is the potential to lose your home if you default on the repayment
  • There can be a temptation to overspend and overborrow since they provide an open line of credit
  • More likely to have a variable interest rate than home equity loans

How to Shop for a Home Equity Line of Credit

When you are in the market for a home equity line of credit, it pays to shop around. Every financial institution will have different home equity line of credit products with different flexible terms and perks.

One thing to look for is the possibility of a rate cap, which simply means that even if your interest rate is not fixed, it will not rise above a certain amount locked in at the beginning of the draw period.

You will also want to keep an eye on the initial draw requirements (if any), closing costs and fees, and the possibility of needing to deal with a balloon payment at the end of the draw period instead of having the option of a repayment period.

How to Manage Your Home Equity Line of Credit

Throughout the lifetime of your home equity line of credit, you may encounter various fees, including closing costs, title fees, appraisal costs, annual maintenance fees, prepayment fees, and even inactivity fees. Ensure that you read the terms of your account thoroughly and keep your HELOC up-to-date and active to avoid any hidden fees or unnecessary costs. 

One of the most important things to keep in mind with a home equity line of credit is the need to be prepared for the payback period at the end of the draw period.

You will have a repayment period in which your access to funds has ended, but you can continue making low monthly payments to pay down your outstanding balance and close out your HELOC.

Before taking out a home equity line of credit, you need to be clear on all of your fees, the payment schedule, and how repayment will work after the draw period.

Related: Home Equity Fees and Terms Explained

Ready to Apply for a Home Equity Line of Credit?

At UCCU, we want our members to love where they bank. Community members have benefited from our history of providing consistent and reliable service since 1956.

We offer various home equity line of credit options, each with its own terms and advantages. Best of all, every home equity line of credit at UCCU comes with no origination fees and no closing costs.

Talk to a UCCU Home Equity Expert today or review different home equity options at the link below.

Home Equity Loan vs. Home Equity Line of Credit: How Are They Different?