What is a 'Home Equity Line of Credit - HELOC'
A home equity line of credit (HELOC) is a line of credit provided to a homeowner who uses the borrower's property as collateral. Borrowers are pre-approved for a certain spending limit, based on household income and credit score, and can use this limit at their discretion. Interest is charged at a predetermined variable rate, which is usually based on prevailing prime rates.
Once there is a balance on the loan, the homeowner can choose the repayment schedule, provided the monthly minimum interest payments are made. The term of a HELOC can range from less than five to more than 20 years, at the end of which the entire remaining balance must be paid in full.
You only pay interest on what you actually borrow and there are no closing costs. You may borrow up to $100,000 ($50,000 if married, file separately) and deduct the interest from your income tax. Homeowners who participate in an equity accelerator program can pay down their mortgage bills more faster.
“TruthinEquity made it possible for us to keep more of our money.”
How much can you borrow?
The loan-to-value ratio for most secondary loans such as HELOCs is usually set at 80%, although in some cases it may be higher for those who qualify. LTV is calculated by dividing the remaining loan balance of a mortgage by the current market value of the home. Let's say you have a 30-year mortgage plan in your home for five years. A recent appraisal puts your home's value at $250,000, and you have $195,000 left on the original $200,000 bill. If no other debts are registered with the house, you have $55,000 in equity. Your LTV is 78%.
Basically, this means you can borrow up to 80% of your home's appraised value, minus the amount you still owe on your primary mortgage. Of course, the actual amount awarded will depend on the borrower's financial situation and credit score. There are even some loans that can exceed 100% of the LTV ratio, but most financial planners warn borrowers against this form of loan because they offer a great foreclosure opportunity and interest on a balance that exceeds the value of the loan. home exceeds, cannot be tax deductible.
Lenders are required to disclose how interest is calculated, the consequences of non-repayment, the terms and interest rates charged by the loan, and other relevant details, such as the borrower's right to rescind.
How HELOCs work
As a form of revolving credit, a home equity line works like a credit card and in fact sometimes with a credit card. Borrowers can withdraw money whenever they need it through this credit card or special checks.
HELOCs are often considered a type of home equity loan. However, a home equity loan works like a conventional fixed-rate mortgage. You borrow a fixed amount at a fixed interest rate and make equal payments for the entire loan term, which can last anywhere from five to 30 years. A HELOC loan term, on the other hand, consists of two parts: a draw period and a repayment period. The draw period, during which you can withdraw money, can last for 10 years and the repayment period can take another 20 years, giving the HELOC a loan of 30 years. Once the drawing period has ended, you can no longer borrow money.
During the HELOC draw period, you do have to make payments, but they are usually small, which often amounts to paying back only the interest. During the repayment period, payments become significantly higher as you are now repaying the principal. During the 20-year repayment period, you must repay all the money you have borrowed, plus interest at a variable rate. Some lenders give borrowers the option to convert a HELOC balance into a fixed-rate loan at this time.
Still, the monthly payment can almost double. According to a study conducted by TransUnion, the payment of $80,000 HELOC at a 7% annual rate will cost $467 per month for the first 10 years when only interest payments are required. That jumps to $719 per month when the repayment period begins.
That jump in payments at the start of the new period has resulted in a payment shock for many from an unprepared HELOC borrower. If the amounts are large enough, it can even default on those who are in financial difficulties. And if they don't make the payments, they could lose their house - the collateral for the loan, remember.