Many people do this to help make repairs and upgrades to their home; pay for school or medical bills; pay off credit card debt – no matter what – a home equity line of credit can help a homeowner in multiple ways. However, like any “loan” there are many factors to consider and lots of terms and possibly even fees you may never even thought of if you have never had one.
The good news is that the Federal Reserve Board puts out an e-brochure entitled, “What you Should Know About Home Equity Lines of Credit” to help home owners better understand what a home equity line of credit means and how it works. First of all, the Federal Reserve wants home owners to know that a home equity loan is a “…form of revolving credit in which your home serves as collateral.”
This is usually how it works: Lenders “…set the credit limit on a home equity line by taking a percentage (say, 75%) of the home’s appraised value and subtracting from that the balance owed on the existing mortgage.” For example, the e-brochure lists the following examples:
- Appraised value of home $100,000; Percentage x 75%
- Less balance owed on mortgage – $ 40,000
- Potential line of credit $ 35,000
While these formulas are a starting point for any financier, a lender will also look at a home owner’s ability to repay the loan; credit score and other factors that will be taken into consideration. Also the Federal Reserve says that many lenders will cap a homeowner’s ability to take out a home equity line of credit – for example a home owner may only have the first ten years of ownership to take advantage of such a loan.