Table of Contents
- What Are Netting Escrows & How Does It Work?: The Best Guide - January 2, 2024
- The Secret About Prescriptive Easement: Top Guide 1 Must Know - December 4, 2023
- About Home Equity Loans In Texas And How Can One Obtain It - November 27, 2023
About Home Equity Line of Credit (HELOC)
The ability to build equity over time is one of the biggest perks of homeownership.
This equity can be used to secure low-cost funds for the second mortgage of either a one-time loan or a home equity line of credit (HELOC).
A HELOC provides you with a revolving credit line to use for large expenses or to consolidate higher-interest rate debts.
Compared to some other common types of loans, a HELOC often has a lower interest rate, which may be tax-deductible.
As the tax rules change it is advisable to consult your tax advisor regarding interest deductibility.
How does a HELOC work?
With a HELOC you would be borrowing against the available equity in your home and the house is used as collateral for the line of credit.
There are two phases to most home equity credit lines. First, is a draw period, which is often for 10 years, during this time you can access your available credit as you choose.
During the draw period, HELOC contracts only require small, interest-only payments. The loan enters the repayment phase after the draw period ends.
Just like with a credit card as you repay your outstanding balance, the amount of available credit gets replenished.
Meaning if you need to you can borrow against it again, and throughout your draw period which is for a period of 10 years, you can borrow as much or as little as your need, till you reach the credit limit you establish at closing.
At the end of the draw period, the 20 years repayment period begins.
Qualifying for a HELOC
You need to have available equity in your home if you need to qualify for a HELOC, which means the amount you owe on your home must be less than the value of your home.
You can borrow 85% of the value of your home deducting the amount you owe. Just like the time when you got your first mortgage, now the lender will look at your credit score and history, employment history, monthly income, and monthly debts to qualify you.
Variable interest rate
Usually, you have a variable interest rate on your home equity line of credit, where the rate can keep changing from one month to another. This variable rate is calculated from both an index and a margin.
Banks use an index, which is a financial indicator to set rates on many consumer loan products.
As the index for HELOCs most banks, use the U.S. Prime Rate, which is published in The Wall Street Journal. The index, leading to the HELOC interest rate, can move up or down.
A margin is the other component of a variable interest rate, which is added to the index. And throughout the life of the line of credit, the margin is constant.
You’ll receive monthly bills with minimum payments that include principal and interest when you start withdrawing money from your HELOC.
Depending on your balance and interest rate fluctuations, the payments may change and they may also change if you make additional principal payments.
You can save on the interest you’re charged and also you can reduce your overall debt more quickly if you make additional principal payments when you can afford them.
Fixed interest rate option
A few lenders, allow you to convert a portion of the outstanding variable-rate balance on your HELOC to a fixed rate.
The payments you make on a balance at a fixed interest rate are foreseeable and steady and they can protect you from rising interest rates.
There are costs and benefits to the flexibility that a HELOC offer.
Pros:
- The cost would be lower than other types of loans
- As long as your bank does not require any minimum withdrawals you can borrow against your credit line at any time, and the untapped funds do not attract interest. So it’s a nice emergency source of funds.
- If you are in need of cash and have equity in your home taking out a HELOC may be a good option.
- If you use the funds on the home then you stand a chance for tax breaks.
- You have the ability to borrow large amounts of cash
Cons:
- HELOCs can sometimes get you into trouble. In spite of your intentions, you may spend available funds on nonessentials.
- The interest-only payments in the draw period would mean payments in the repayment period runs to almost double.
- When you use your home as collateral you reduce the equity in your home.
- If the real estate market drops and if you have a CLTV ratio then you go underwater on your loan.
Conclusion
Sometimes in your life when access to extra cash is a necessity, a second mortgage can be a compelling option.
Lenders may be willing to offer you rates that are lower than most other types of loans because it’s secured against the equity value of your home.
But the extra loan payment, which comes along with a HELOC should be included in your monthly budget.
A second lien is placed on the home by the bank, so if you’re unable to make the payments, your home could be at risk of foreclosure.
