A Home Equity Line of Credit (HELOC) is a form of revolving credit where the borrower’s home serves as collateral. With a HELOC, the borrower is approved for a specific amount of credit. Many lenders determine the credit limit on a HELOC by taking a percentage of the home’s appraised value and subtracting that from the balance owed on the existing mortgage. The borrower’s credit history, income, debts, and other financial obligations will be reviewed. Once approved for a HELOC, the borrower will likely be able to borrow up to the credit limit whenever they want. Home Equity Lines typically involve variable rather than fixed interest rates. The variable rate is based on a publicly available index (like the Prime Rate or US Treasury Bill rate). Therefore, the interest rate paid will change based on changes in the value of the index.
Most lenders will determine the interest rate you pay based on the value of the index at a specific time plus a “margin” such as 2 percentage points. Because the cost of borrowing is tied directly to the value of the index, it is important to find out which index is used, how often the value of the index changes, and how high it has risen in the past. It is important also to note the amount of the margin. Variable rate loans secured by a dwelling must, by law, have a cap on how much your interest rate can increase over the life of the loan.