A Home Equity Line Has Two Phases

A home equity line is often compared to a credit card secured by a house. That is accurate for part of its life and misleading for the rest.

The draw period behaves like revolving credit

During the draw period a borrower can take funds up to a limit, repay them and take them again. Availability replenishes as the balance falls.

Payments in this phase are commonly interest-only, or a small percentage of the balance. The principal is not required to fall and often does not.

The rate is usually variable, tied to an index plus a margin. A payment that is interest-only on a variable rate moves whenever the index moves.

The repayment period behaves like an installment loan

When the draw period ends, further borrowing stops and the outstanding balance is amortized across the remaining years of the term.

The payment must now cover principal as well as interest, compressed into a shorter span than a mortgage. The increase is frequently substantial.

Nothing unusual has happened at that point. The contract always said the phases were separate; the borrower experienced only the first one.

Why the line can shrink before you use it

The credit limit is not guaranteed for the life of the agreement. Lenders retain rights to reduce or suspend a line under conditions set out in the contract.

Common triggers include a significant decline in property value, a material change in the borrower's financial circumstances, or default on the agreement itself.

A borrower holding a line as an emergency reserve may find it reduced precisely when conditions are poor, because the same conditions trigger the review.

The lien position sets the price

A home equity line usually sits behind the first mortgage. In a forced sale, the first lien is paid before the second sees anything.

That subordinate position is why rates are higher than a first mortgage and why available equity is calculated against the combined balance of both liens.

It also means refinancing the first mortgage involves the second lender, which must agree to remain subordinate or be paid off in the process.

Risk sits in a different place than with unsecured credit

The consequence of nonpayment is not simply collection activity. The debt is secured by the residence, and enforcement follows foreclosure procedure.

Those procedures, and the protections attached to them, are governed by state law and change over time. They differ enough between states that general summaries are unreliable.

Anyone facing difficulty on a secured home debt is in territory where a housing counselor or an attorney is the appropriate next step rather than an optional one.