A home equity loan and a home equity line of credit (HELOC) are both loans secured by the equity in your home. A home equity loan is a lump sum amount with regularly scheduled payments. Typically, these loans are used for home improvements or other items specifically identified before the loan is taken out. A home equity line of credit is a revolving credit account. You pay for things with your line of credit and then you pay the loan back. You should use these credit instruments when you would otherwise have to borrow money.

When Should You Use a Line of Credit?

Sometimes, people are afraid that their lender will freeze their line of credit and they rush to use it first. So, the question is when should you use your home equity line of credit?

You should use your home equity line of credit when you would otherwise have to borrow money in order to pay for something. For instance, you can pay for your college education with your credit line or use your credit line to pay medical bills. You can also use your credit line to pay for home repairs. You should not use your credit line to pay for everyday expenses, such as for food and gas, just as you would not charge those items to a major credit card and carry the balance at a high interest rate.

In certain circumstances, your lender can freeze or reduce your line of credit. Your lender's right to do that should be spelled out in your home equity line of credit loan documents or the contract that you signed when you set up the line of credit. Usually, the plan allows the lender to freeze or reduce your line of credit:

  • If the value of your home declines significantly, or
  • When the lender reasonably believes that you will be unable to make your payments due to a material change in your financial circumstances

So, for example, if a fire burns part of your house and you cannot make adequate repairs or if the price of homes in your neighborhood declines a lot, your lender might reduce your credit line. Also, if you lose your job and you are not able to find another job with comparable pay, your lender might reduce your credit line.

Alternatives

If your lender freezes or reduces your line of credit, you should talk to your lender first to see what caused the lender to take that action and what you can do to restore it. You may be able to show that the lender was wrong by producing an appraisal of your home which shows that your house has retained its value. You might also show the lender that there has not been a material change in your financial circumstances.

You should get a copy of your credit report to see if there has been any negative information added there. If there has been, you should challenge it (see Correcting Errors on Credit Reports). If your lender suggests getting a new appraisal, discuss appraisal firms with the lender and make sure that the lender will accept the new appraisal, and find out who pays for the appraisal.

If your lender does not want to restore your line of credit, look around for another lender. There are many lenders available, and you may be able to replace your line of credit with a different line of credit.

Questions for Your Attorney

  • Can I pay for my son's college education with my home equity line of credit, and can a claim an income tax deduction for the interest on my home equity line of credit?
  • Can my lender reduce my home equity line of credit if I lose my job?
  • What should I do if my lender reduces my home equity line of credit?