HELOC stands for Home Equity Line of Credit. It’s a variable-rate loan, which works just like a credit card. In fact, it comes with one in some cases. How much you can borrow depends on the amount of equity your home has. Perhaps you’ve recently retired, or your child just got admitted into that fancy Ivy League school of their dreams. Instead of taking out a loan from a credit card company, take it out from the value your home has accumulated. Applying for a HELOC is relatively easy, and it attracts lower closing costs.
The expression, “your home is a piggy bank” refers to the accumulation of equity. Tap into your home’s equity to fund a renovation project or to take that trip around the world you’ve been putting off.
Here are the six important things to know about how to get a HELOC:
1. The Duration of the Introductory HELOC Interest Rate
In some cases, lenders use low introductory rates to snag your business. That’s fine, but remember to take note of how long the low rate is valid, and what it will rise to once the introductory period is over.
2. How HELOC Interest Rates Are Calculated
A home equity line of credit comes with variable interest rates. Your rate could fluctuate depending on the prime rate. Like a primary mortgage, a HELOC is secured by your home, but with one main difference. If you default, a HELOC is second in line after the first mortgage to benefit from the proceeds of a repossessed property.
For this reason, HELOCs attract higher interest rates compared to primary mortgages, but their rates are lower than those for credit card debt or personal loans. First-lien HELOCs, on the other hand, are first in line in the event of a default. These are recommended for homeowners who need a loan but don’t have a mortgage.
3. Beware of Prepayment Penalties
If you put your house on the market, you will be required to pay off the home equity line of credit, and a fee may be charged for the cancellation or prepayment of the HELOC. If you plan to sell the house during this period, avoid taking out a HELOC that comes with cancellation or prepayment fees.
If your home has substantial equity, taking out the maximum allowed amount may be tempting. But, just like having substantial credit on your credit card, you’ll end up spending a little here, some more there, and before you know it, you will have drained most of your home’s equity. Regardless of where you’re getting your HELOC and the amount of line of credit being offered, only take what you can afford or need.
4. Application Process
During a HELOC application, the lender needs to review a few things to verify if you are eligible for the loan. They will review your credit history and may ask for a new appraisal of your home to confirm its value and the actual current market value. To qualify, you should have over 20% equity on your home based on the current appraisal. You should also have a credit score of about 620 or more, a good credit history, and a low debt-to-income ratio.
Once all these factors line up, chances are high that your application will be approved. The lender will authorize a line of credit for you.
5. Draw Period
A HELOC works the same way a credit card does. During the draw period, you can borrow up to 80% of your home’s value or the actual amount your lender has approved. The draw period is the length of time you can withdraw cash from your credit account through a HELOC.
You can get a draw period of 5 or 10 years. For instance, a 5 year draw period means you can borrow money for 5 years. During a draw period, you can carry forward a balance from the previous month to the next. However, you are still required to make minimum payments. The amount of money borrowed during a draw period only requires interest payment on the actual amount borrowed.
6. Repayment Period
The repayment period comes after the draw period has expired. Most repayment periods are between 10 to 20 years. During the repayment period, you are required to pay the principle of the HELOC plus accruing interest. The loan balance is broken down where you’re required to make monthly payments until the loan is fully paid. This amount is added to your mortgage payment, which is unaffected by the HELOC.
Some HELOC terms require one to pay the entire balance once the draw period ends, which is referred to as a balloon payment. The term balloon payment refers to a large sum of money. To understand the repayment terms on your HELOC, ask for full disclosure during the application process.