Understanding a Home Equity Line of Credit

What is a home equity line of credit? A home equity line of credit is a revolving loan, with a minimum and maximum amount of withdrawal.

And what makes the availment of a home equity line of credit a viable loan option in comparison to a home equity loan?

There's the ease of use in accessing the loan. This can be as trouble-free as writing a special check to access the account, the use of your credit card or ATM machines to get funds. Also, you only pay interest on the amount you've used. And have the option of renewing the credit line when the draw period expires.

On the other hand, the home equity loan is paid to you in a one-time lump sum manner, immediately after the contract has been signed. Once you have received the entire amount, you can no longer borrow on that account.

This offers you the flexibility of accessing the amount you need to borrow when you want to for duration of the agreement. If you are planning to use the loaned amount in installments such as college tuition fees, or as a stopgap while you are unemployed, take out a home equity line of credit.

Financial experts generally recommend the use of a home equity loan for big-ticket items, like a car or yacht, medical emergencies or for renovating a home.

With the use of a home equity credit line, you can postpone paying the principal for an agreed upon number of years or pay a special discounted interest rate. On the opposite side of the spectrum, a home equity loan requires you to pay the principal and interest fees for the duration of the entire loan.

If you have a disciplined attitude towards managing your funds, then a home equity credit line will work for you. You'll use it only when needed.

You'll enjoy more choices of payment options based on interest rates. Some lenders offer a flexible interest rate or one where the borrower pays the principal plus interest; it's all up to the borrower. Or you can also decide on a fixed monthly payment schedule.

In addition to this, a home equity credit line has shorter payment term schedules. With a home equity loan, you are paying for the convenience over a longer period of time.

However, there are two features a home equity line of credit has, that need to be weighed together with the advantages:

A home equity line of credit places a large amount of credit at your disposal. However if you default on the loan payments, you run a real risk of losing your home. Conversely, this is why it is attractive to lenders, because their experience has shown them very few borrowers default on payments.

The second feature is the possibility of being liable to pay a large repayment amount at the end of the home equity line of credit. Ask the lender if this is a feature of the loan, and if so, assess your ability to pay this amount. If you feel you don't have the capacity, then have a renewal option built into the contract.

There are no cut and dried answers to the question of whether a home equity line of credit is the best loan option for you. As a borrower, you must assess your need for the loan, the purpose you'll use it for, and your capacity to pay. Only then will you be able to make an informed decision about this loan.