Home Equity Line of Credit (HELOC)

Home equity lines of credit or HELOCs, are a popular source of secured credit for people who require loans in small installments. HELOCs help people borrow against home equity. The equity on the house which is determined by having the home appraised, decides the credit limit of the borrower. The choice regarding how to borrow against this built up equity depends on the kind of financing required by the homeowner. Generally a HELOC is advisable when a homeowner needs money on an ongoing basis for home improvements or for meeting financial commitments like paying for a child's education, a wedding and so on. Interest is paid on the amount withdrawn, using a credit card or a check.

Applying for a HELOC

Getting the Home Appraised: Is it as Easy as Before?

Home appraisal is essential in order to obtain a home equity line of credit. The appraised value of a home is defined as the difference between the market value of the house and any remaining mortgage balance. The present financial turmoil has made this seemingly easy task, very complex. There are three ways of appraising real estate:

Comparative Sales Approach

In this case, property appraisal hinges on finding comparable property prices. A comparable property is one that is similar in size and age and one that is located in a similar neighborhood. An approximate average of comparable property prices provides the fair market value of the home being assessed. In case the property being appraised has a few additional features or lacks a few amenities, the appraiser adjusts the price accordingly. If the benchmarked properties undergo a distress sale, the price of the property being appraised would definitely decline. This in turn would reduce the built up equity on the house. Property prices are now at an all time low because the housing market crashed. This has negatively affected the built up home equity.

Cost Approach

In this case the appraiser estimates the value of the vacant land using the sales approach. He then adds the replacement cost of improvements (on the land). Improvements on land refer to the structures built on it. In other words the cost of the house at the current market price is the replacement cost of improvement on the land. Any depreciation on the house is a charge and is subtracted. Since it is required that we estimate the replacement cost of improvements at the current market price, a decline in the price of real estate would have a negative impact on the market value of the house. A redeeming quality of the cost approach is that the price of the vacant land may not fall drastically. This is because land is a limited resource.

Income Capitalization Approach

In case of the income capitalization approach, the expected return on investment and the net operating income play an important role. The return on investment (ROI) should at least be equal to the cost of capital to justify the investment. The net operating income, which is obtained by making adjustments to the gross rental income divided by the ROI to obtain the market price of the property.

Net operating income = Gross rental income - Operating expenses + Operating revenues

The average rent for homes/apartments has declined because of rising unemployment and fears that the worst is yet to come. In this scenario property appraisal produces a dismal figure since the expected ROI for a homeowner who invested during boom time is fairly high.

Freeze on Home Equity Lines of Credit

Banks have started freezing the home equity lines of credit because of downturns in the US economy and declining home prices. In other words, credit that was sanctioned against home equity but was not withdrawn is now withheld by the banks. The situation does not bode well for people who were using their HELOC to meet pressing financial commitments.

Although a home equity line of credit has many advantages, the current situation does not auger well for homeowners who are thinking of borrowing against their equity. The ultimate decision of whether or not to apply for a HELOC would depend on an individual's financial position.