How a HELOC Works

A “HELOC” or “home equity line of credit,” is a type of home loan that allows a borrower to open a line of credit using their home equity as collateral.

They can then draw upon it to pay for anything they wish, such as home improvements, or to pay off credit card debt or student loans. The money can even be used for a down payment on a subsequent home purchase. HELOCs are typically taken out as second mortgages that are subordinate to an existing loan.

This means you wind up with two monthly payments, but can access cash without disturbing the interest rate or loan term on the first mortgage. As such, you can continue to enjoy your low fixed-rate if you secured a very cheap 30-year fixed mortgage at some point in the past.

What Is a HELOC?

• A home loan with a twist because it’s actually a line of credit (as opposed to a set loan amount)
• Your property acts as collateral for the loan similar to a traditional mortgage
• Can draw upon it when needed like a credit card, which could be many times over the loan term
• Or never touch it (some homeowners simply open one as an emergency fund)

A HELOC, while also backed by real property, differs from a traditional home loan for several different reasons. The main difference is that a HELOC is simply a line of credit a homeowner can draw from, up to a pre-determined amount set by the mortgage lender, based on the value of your home. Conversely, with a typical mortgage, the amount borrowed is the total amount financed. In other words, a HELOC is a lot like a credit card because of its revolving balance nature. When you open a credit card, the bank sets a certain credit limit, say $10,000.

You don’t need to pay interest on the total amount, or even withdraw or spend any of the $10,000, but it is available if and when you need it. That’s also how a HELOC works. Your bank or lender will give you a line of credit for a certain amount, say $100,000, depending on the available equity in your home. And you can draw upon it as much or as little as you’d like, up to that $100,000 limit, if and when you want.

Most people use the HELOC funds to pay for things like paying for college tuition, home improvements, and higher-interest rate debt like credit cards (debt consolidation). Or to cover a down payment on another home purchase (instead of raiding their 401k or Roth IRA).

Accessing Your Funds with a HELOC

• You may be given an access card (like an ATM/credit card)
• An option to transfer funds online to your bank account
• A physical checkbook where you can write checks
• Or a bill pay option to make specific payments

Once your HELOC is open, you’ll have a variety of options to access the funds up to your pre-determined credit limit. Most banks and mortgage lenders will provide you with an access card that works kind of like an ATM debit/credit card. You can make purchases with it and/or withdraw cash at a branch location.

You may also be given the option to transfer funds to a linked bank account, or be given checks that can be written to anyone for any purpose, which are deducted from your credit line. There may be a bill pay option if you want to use the funds to pay bills, or an option to transfer funds over the phone/via mobile banking. In any case, it should be pretty easy and convenient (and usually free) to access your money.

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