There may come a time when you face a situation when you need money that is above and beyond your emergency funds.

We may all face them at some point, whether it’s a medical emergency, car or house situation, or perhaps something with the kids like a huge tuition bill or family issue you need to help solve. What can you do? There are several solutions, but today I’d like to address a common but often misunderstood one, the home equity line of credit, or HELOC.

What Is a Home Equity Line of Credit?

First, let’s talk about home equity. The equity is the difference between what you owe on your home to pay off any mortgage and the current market value of your home.

For example:

• You buy you your home for $250,000 with a 20% down payment ($50,000) in 2010
• Your original 30-year mortgage is $200,000
• Today, your home’s market value is $265,000 when appraised, and you currently owe $190,000 on your mortgage
• Your equity is $75,000 (home value $265,000 – your mortgage debt $190,000)

Next, don’t confuse a HELOC with a home equity loan. A HE loan is executed when you are given money by the lender based on the equity you have in your home. You are given a lump sum at the time of approval. Generally, you can borrow up to 80% of the equity in your home when you qualify with excellent credit, proof of income, and other debt considerations. In the example above, a well-qualified borrower could obtain a loan of up to $60,000. HE loans are second-tier loans behind your debt as a first mortgage. There are application fees and closing costs, which can be especially troublesome when you are hurting for approval and need funds right away. HE loans become part of your debt on your home in addition to your existing mortgage, like a HELOC, but is generally more expensive to obtain.

HELOCs, on the other hand, offer a slightly different scenario with some advantages and disadvantages.

Generally, they cost nothing to apply for and process. The equity calculations are done the same way as in a HE loan, however, when the credit line is approved, you do not have to draw any funds from it until, if ever, you need it. And it will cost nothing to have it available to you for the term of the line period (usually 10 or 15 years). In this way, it is perfect as insurance so that if and when you do have a real need for this kind of money, it is there and ready for you. It can be drawn simply with free checks that the lender supplies to you (or another method, such as a debit card tied to the credit line), and from there, you will be billed monthly for repayment. However, just because it is easy to access the money doesn’t mean you should do so without careful consideration.

Interest rates on HELOCs are generally much lower than on a credit card (which makes them an interesting option for debt consolidation, but only if you have solved your issues with incurring new debt). Unlike your credit cards, which are unsecured, a HELOC is a secured loan tied to the value of your home. It must be used responsibly. Otherwise, you could risk the eventual loss of your home. Also, if the home loses value, you could find yourself “underwater,” owing more on the home than it is worth, at this point, the lender may freeze your line of credit.

Because a HELOC is based on your equity, your credit history and credit score don’t majorly affect getting approval; however, it can affect your interest rate.

While the interest rates on HELOCs are not fixed but variable (which means they can go up during the HELOC’s existence), there are rules about when and how they are increased and the notification you receive in advance of it doing so. You also can have the option to pay interest only, and no principal, for long periods (as much as 10 years) on any monies you borrow, and after that time, if you still owe anything, you can pay off the loan in full, or you can refinance it into a HE loan for another period (10 or 20 years).

Many lenders, like major banks, offer a special discount on your line of credit rates if you have payments automatically withdrawn from your checking or savings account.

These loans also have tax-deductible interest, which you can use to your advantage.

You can usually pay off a HELOC before the term ends without a penalty, or as you need to, you can borrow more, even after you have borrowed some and paid a portion back. It gives you great flexibility, and it may be the best way to finance your needs in some situations. However, as with anything in life, make sure you understand the terms of the agreement so you can avoid unpleasant surprises in the future.

Whether you use a home equity line of credit or a HE loan, or any other type of borrowing is, of course, your choice, but even if you never use the HELOC, it seems like a no-cost way to ensure that if serious money problems arise you have a safety net to fall back on. I know I like having that kind of security.

What would you do if a financial need arises that you simply don’t have available funds to cover?

This article was originally published on Wealth of Geeks.