15 Facts You Should Know About Home Equity Line of Credit

• The Home Equity Line of Credit is a revolving (or open-ended) credit line that, in principle, operates in much the same way as a credit card. However, where credit cards are unsecured, the HELOC is secured (usually as a second mortgage) by your home. Defaulting on a HELOC can, therefore, result in foreclosure.

• HELOCs generally require less paperwork than standard loans and can often be closed within a week of application. Points and origination fees are rarely charged, so they usually have substantially lower closing costs, as well. The fees that are charged for a HELOC (such as recording fees; updated appraisals, if necessary; etc.) can often be deducted from the credit line, making the HELOC a true “no money down” loan.

• Although some lenders advertise HELOC loans of $500,000 or more, your actual credit line will be based upon the amount of equity that you have in your home. For example, if your home is worth $200,000 and you owe $125,000 on it, you could get a HELOC second mortgage with a credit line of up to $75,000 (assuming that the lender’s maximum allowed combined loan-to-value ratio is 100%; some may go as high as 125% of the home’s value, which can be extremely risky).

• HELOCs have an adjustable rate, and like other adjustable-rate mortgages (ARMs) their interest rate is composed of an index and a margin. The index is a financial indicator; this is the portion of the interest rate that actually adjusts. Most HELOCs are indexed to the Prime Rate. The margin, which is the lender’s cost of doing business plus a profit amount, is set at loan approval and remains the same for the life of the loan.

• You can’t compare the quoted annual percentage rate (APR) for a HELOC with the APR of a standard loan. This is because normal APRs factor in origination fees and other upfront loan costs. A HELOC’s APR does not include these fees; it refers simply to the loan’s interest rate.

• HELOC interest charges are computed on a daily- rather than monthly basis. Generally, the average daily balance of the month is multiplied by the daily interest rate (which is the current interest rate divided by 365); that total is then multiplied by the number of days in the month. Minimum monthly payments can therefore change depending on purchases made and interest rate fluctuations.

• HELOCs have a draw period (generally ten years) during which you can continually use the credit line, with only interest payments normally being due. As it’s repaid, the line can be used over and over again, as with a credit card. After the draw period ends, the outstanding balance becomes amortized to be retired during the remainder of the loan’s life (the repayment period, which is typically an additional ten or twenty years).

• HELOCs offer the advantage of flexibility. You only pay interest on the amount of the credit line that you actually use, and you can use as much or as little as you want. You can also add an additional amount for principal payment if you desire.

• You also have certain tax advantages with HELOCs. Most interest is tax-deductible, which isn’t the case with credit card interest. Also, HELOC rates are usually lower than those of credit cards.

• Most HELOCs give you the capability of accessing your line of credit by writing special checks that are provided or using a credit card that’s linked directly to the loan.

• You can advance cash whenever you need it (during the draw period, of course). This makes the HELOC useful as a source of emergency funds for those who are “savings-challenged”.

• HELOC funds can be used for any purpose you wish, from debt consolidation and home improvement to buying a new car and paying for your family’s vacation. The funds can even be used to buy other properties.

• A nominal annual fee is charged, generally between $50 and $100. This fee is applied whether you have an outstanding balance or not.

• Some HELOCs can be “converted” from an adjustable- to a fixed-rate loan. This can be especially useful when interest rates begin to rise because, unlike standard ARMs, HELOCs have no rate caps (which limit the size of any interest rate changes). HELOC maximum rates are generally set at 18%.

• Market interest rates can affect HELOC rates very quickly. Most standard ARMs have predetermined initial fixed-rate periods of one-, three-, or even ten years. With the exception of a possible guaranteed introductory rate (which usually lasts for no more than a few months) a HELOC’s interest rate can change monthly, depending on the index.

Sphere: Related Content

No comments: