There is a resurgence of home equity lines of credit among banks after numerous signs point to a strengthening housing market.
New home equity lines of credit are expected to rise 16% this year to 91 billion dollars and increase to 97 billion by next year. These types of loans can be an excellent alternative to taking out credit card debt, though certain levels of risk obviously apply. Let’s examine the history of this lending option and look at some of the basic characteristics of how these loans function.
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A Brief History of (HELOCs)
Home Equity Lines of Credit or (HELOCs) were common in the years prior to the collapse of the housing market. People would often take out lines of credit on their house and use the money to go on vacation or to upgrade their home. The problem is that much of the lending that occurred was based on the speculation that home prices would continue to go up.
When home prices started to go down there were millions of people who were more or less left holding an empty bag. They had only been paying the interest on the loan and simply weren’t in a good position to pay the loan back. Many of them went into foreclosure and banks started freezing lines of credit in order to prevent more consumers from potentially going into foreclosure.
In the following years, the housing sector has seen some noteworthy improvements. Home prices are rising once again. Home purchase sales are up and foreclosure rates remain at 5 year lows. On top of all of that, record low home interest rates are helping millions of Americans to save thousands of dollars every year through refinancing. Consequently, banks have started offering more home equity lines of credit.
How (HELOCs) Work
A home equity line of credit is different from many other types of loans. First, the value of the loan is not given to the borrower in a lump sum. Rather, the borrower is given in lines of credit that add up to the total credit limit that is established.
Unlike some other types of loans, the interest rate on a HELOC is variable. The interest rate is typically based on an index such as the prime rate. Borrowers should take this into consideration if they are thinking about taking out a line of credit with their home.
One of the main reasons that HELOCs have traditionally been popular is that the loan amount is often deductible under many federal and state tax laws. This has allowed HELOCs to be a cheap alternative in most situations from many other types of loans. Another factor to consider is that the repayment schedules for HELOCS are determined by the borrowers.
Even with all of these benefits it’s important to understand what is at stake when taking out a HELOC. The borrower’s home is the collateral and failure to pay back the loan may result in foreclosure. Personal responsibility and adequate planning must be part of taking out any loan, including a home equity line of credit.
