Home Equity Line of Credit (HELOC)

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Home Equity line of Credit (HELOC)

Using a credit line to borrow against the equity in your home has become more popular over the past five to six years with the rising property values we have experienced across the United States. Equity credit lines come is a variety of shapes and forms.

Most equity credit lines are prime based and come with variable interest rates. Some come with attractive "teaser" rates (i.e. low introductory rates that last from 1-month to a year), and more recently some lenders have introduced fixed rates for part or all of the credit line. Some loans have large one-time upfront fees, others have closing costs, and some have continuing costs, such as annual fees. Often equity lines of credit have a balloon after 5 or 10 years, and others have no balloons but higher monthly payments.

No one loan is right for every homeowner. A good mortgage broker can educate you as to the various home equity credit lines that are available and determine which type best suites your needs.

It is important to ask a lot of questions to insure that you are getting what works for you, and at the end of the process be sure to review the home equity contract carefully prior to signing it to insure that you are getting what you thought you were getting and compare the fees to what you were quoted.

Is a home equity credit line right for you?

If you need to borrow money, home equity lines can be an inexpensive way to free-up cash versus obtaining a new first mortgage. Initially at least, a credit line can provide you with a large amount of cash at relatively low interest rates. Certain tax advantages exist with credit lines that are unavailable with other types of loans. (Check with your tax adviser for details.)

Home equity lines, of course, are secured by your home (or investment property). Naturally, this puts your home at further risk especially if you are unable to make your monthly payments. Those loans with a balloon payment may lead you to borrow money in the future to pay off the home equity line of credit that you may or may not qualify for at that time. If you decide to sell your property, the credit line must be paid off unless you make arrangements prior to close of sale to re-secure the credit line on another property. Because home equity loans give you relatively easy access to cash at generally reasonable interest rates, retaining large higher-rate credit card debt will not make sense for many.

You may also want to consider obtaining an amortized second mortgage instead of a credit line. If you do not plan to be paying down the credit line, lower interest rates and guaranteed payments may be available by obtaining a second mortgage instead. However, if you regularly receive large lump sums of cash throughout the year a home equity line of credit may be more beneficial as you can pay down the loan thus saving interest cost while the money remains accessible if you need it.

How much money can you borrow on a home equity credit line?

Depending on your creditworthiness (your income, credit rating, etc.) and the amount outstanding on your first mortgage, home equity lenders may allow you borrow up to 100% of the appraised value of your home less the balance you owe on your first mortgage. Loan amounts are available up to $10 Million and sometimes more. Some questions that you might consider asking:

What is the length of time the home equity loan can be in place?
Is there is a minimum withdrawal amount required at closing?
Are there minimum or maximum withdrawal requirements after your account is opened?
How do you access your credit line -- with checks, credit cards, or both?
Does your home equity line have fixed time period when withdraws can be made?
If the withdraw period expires, are you able to renew your credit line, and if you cannot, will you be permitted to borrow additional funds?
At the end of the withdraw period, are you required to pay your full outstanding balance, or can you repay the balance over a fixed time?
Is there a teaser rate? If so, how long will it last and how much will your rate increase after the teaser period?
Is your credit line convertible to a fixed rate amortized loan?

What is the interest rate on the home equity loan?

Interest rates can vary greatly between lenders for the same loan. It pays to have a knowledgeable and resourceful mortgage broker to not only save you time but minimize credit pulls versus shopping around for the credit line yourself. Maintaining a high credit score (i.e. FICO score) is even more critical when obtaining a credit line that with a first mortgage as a second mortgage lender has a much higher risk and increases the rate according to your FICO score. Comparing the annual percentage rate (APR) can give you some guidance to compare loan programs but do not rely on it as your sole decision making tool. Please read article.

If you are considering a variable rate, check and compare the terms. Check the periodic cap, which is the limit on interest rate changes at one time. Also, check the lifetime cap, which is the limit on interest rate changes throughout the loan term. Ask the lender which index is used and how much and how often it can change. An index (such as the prime rate) is used by lenders to determine how much to raise or lower interest rates. Also, check the margin, which is an amount added to the index that determines the interest you are charged. In addition, inquire whether you can convert your variable rate loan to a fixed rate at some future time.

What are the upfront costs?

When obtaining a home equity line of credit, you incur many of the same costs associated with a first mortgage. These include items such as an application fee, title search, appraisal, closing agent's fees, and points (a percentage of the amount you borrow). These expenses can add substantially to the cost of your loan, especially if you ultimately borrow little from your credit line. Most lenders give you the option of paying all costs upfront or taking a higher interest rate to offset these costs.

What are the continuing costs?

In addition to upfront closing costs, generally there is a renewal fee payable at the end of each year while the credit line remains open. Some lenders charge a transactional fee every time you withdraw from your credit line. These fees add to the overall cost of the loan.

What are the repayment terms during the loan?

Most credit lines are interest only for the first 5 or 10 years, sometimes longer. Find out how often your interest rate can change and will your payments change accordingly. You may want to ask about penalties for late payments and under what conditions the lender can consider you in default and demand immediate full payment.

What are the repayment terms at the end of the loan?

You need to know if there is a balloon payment after 5 to 10 years, and what are the terms of repayment. If you plan on refinancing the unpaid balance, you want to make sure you are credit worthy (employment and credit are intact) when the balloon comes due. Also, if you decide to payoff and close-out the credit line during the first 3-years there is often a cancellation fee from $350 to $500 payable. If you pay the credit line down to zero and leave it open, the cancellation does not apply.

What safeguards are built into the loan?

The Federal Truth in Lending Act requires lenders and brokers alike to inform you about the terms and costs associated with loan at the time of application. Lenders-brokers must disclose the APR, payment terms and loan fees, such as an appraisal, a credit report and closing fees. Lenders-brokers must disclose that the credit line is a variable-rate loan and provide you with a Truth-in-Lending (TIL) and Good-Faith-Estimate (GFE) just as they do for fist mortgage loans.

Because taking out a credit line increases the financial risk on your home, you have three (3) days to cancel the transaction, for any reason. To cancel, you must inform the lender in writing.

Once your home equity plan is opened, if you pay as agreed, the lender, in most cases, may not terminate your plan, accelerate payment of your outstanding balance, or change the terms of your account. The lender may halt credit advances on your account during any period in which interest rates exceed the maximum rate cap in your agreement, if your contract permits this practice.