A Home Equity Line of Credit (HELOC), is a revolving line of credit secured on the equity in the mortgagor's house, usable for any purpose.  Generally, bank cashiers quality grade checks are given to the borrower to write against the line of credit amount.

A HELOC works like a revolving credit account.  Terms are typically a 10 year draw period, and a 10, 15, or 20 year repayment period that begins at the end of the draw period.  

During the typical 10 year draw period, available funds can be drawn, paid back, or redrawn upon, at any time, up to the limit (usually a minimum $300 withdrawal is required).  

The monthly payment for the amount drawn is most commonly set at 1% of the current balance that includes principle and interest, or, the borrower has the option of making an interest only payment.

A principle and interest payment
Calculated as follows for $10,000 drawn: 
.01 x $10,000 = $100

Note: Many lenders use the below calculation only, and any payment above the interest only amount, is applied toward principle

Draw period interest only payments are based on that months current prime rate.  
If prime is at 4.5% then
.045 x $10,000 = $450
$450/12 months = $37.50 interest only payment

The payback period
The 10 year draw period is now over and funds can no longer be accessed.  The loan must be paid off in whole, refinanced for a fixed-rate loan, or monthly payments begin the payback period.  

Monthly payments during the payback period are higher than the draw period.  The monthly payment for the total balance amount (actual drawn amount less paid principle during the draw period) is calculated by adding the lender's margin to the current the current prime rate (see Adjustable-Rate Mortgage (ARM) loans for details).  

The lender's margin may be set anywhere from  .2% (.002)  to  3.05% (.035).  This  depends on the borrowers credit score, debt ratio, and loan to value.  The lenders margin is then added to the current prime rate (currently 4.2% (.042)  May 12, 2003).

Advantages

• Re-usable credit 
• Lower closing costs
• Lower required monthly payment
• Faster processing time from application to close
• Extremely flexible
• Prime rate is fairly stable
• Tax deductible interest
• HELOC purchases are available.

Disadvantages

• Unstable market conditions
• Higher rate (typically) due to LTV (loan to value)
• interest cap is set (at loan origination) 3 to 4 times that of prime rate
• Must have sufficient equity to stay within LTV 
• Lenders often impose a 3 year prepayment penalty
• Lenders add a margin to prime that increases the interest rate
• Can't payoff with another HELOC
• Must be 5 years since bankruptcy typically for credit scores below 700, and
  7 years for above 700 credit scores. (this is not a misprint)

.
 
See Our Prime Rate Change Table (1975 to 2004)

Consult your accountant about the various tax advantages that may be available to you before securing your loan.

For Commercial Properties See: Mezzanine Equity Kicker