By David Reed
The mortgage industry really isn’t very different compared to others as it relates to industry jargon. HELOC is one of those bits of jargon. What exactly is a HELOC? We’ll explain.
There are different ways to tap into home equity. A common one is a cash out refinance. When someone refinances a loan due to a lower rate, shorter or longer term or part of the process to take someone off the title to the home. When refinancing an existing mortgage, the borrowers can choose to also pull some of that equity out during the process. Refinancing in order to just take out some equity isn’t the best strategy.
A refinance is still a new mortgage. It replaces an existing loan with a new one. Because it’s a new mortgage, there will also be a host of new closing costs needed in order to follow through with the refinance. This is why refinancing for the sole purpose of tapping into home equity doesn’t make sense. A HELOC, however, can.
HELOC is the acronym for Home Equity Line of Credit. Okay, so how does a HELOC work in practice? A HELOC typically comes in the form of a second mortgage, meaning it takes a subordinate role to an existing first mortgage. When the home is sold, the new mortgage pays off the existing first mortgage and the next payoff is the second mortgage. Due to this secondary position, it’s possible, although relatively rare, there won’t be enough funds to cover both the first and the second.
But a HELOC is not simply a second mortgage. Instead, it’s a line of credit. This means someone can borrow some or all of the limit and pay it back over time at their leisure. Most HELOCs do however require borrowers to take out a minimum amount as well as make minimum payments at some point.
The lender will lay out all the terms of the second lien. If a HELOC carries a $25,000 credit line, the borrowers might decide to pull out maybe $5,000. The borrowers can then pay down the balance minimum or pay more. A HELOC can be used over and over again, just like a credit card. Make a charge, then have the option of paying the minimum, a little more than the minimum or the entire outstanding balance.
Most HELOCs work like any other, it’s just the individual lender that sets the terms.