HELOC – What is it?
If you have ever wondered what HELOC stands for, you’re not alone. HELOC is an acronym for home equity line of credit. A HELOC allows someone (the borrower) to take money out or write checks against their home equity. They can do this to a preset or defininte amount.
When you own a home, you’re building equity. Many people use that equity as collateral to borrow money. These types of loans are very popular, especially when you are planning for a large purchase. A normal, conventional loan gets paid back during the loan term and the borrowed money is either given to the borrower or used to payoff student loans, credit cards, a previous mortgage, etc. What a HELOC does, is allows the person borrowing to take out funds up to a certain amount and the montly payments will be determined on the actual money withdrawn.
Let me give you an example. Say you receive a $30,000 HELOC on your home. By doing so, you would be able to write checks against that credit line up to $30,000. After that set amount, your HELOC would stop allowing you to take out against it. You should remember that the amount you withdrew from the credit line will determine your monthly payments, i.e., if you had only borrowed $10,000, then that is what your monthly payment would be based on.
Another way of helping people understand a HELOC is comparing it to a credit card, or "giant" credit card if you will. The collateral on this giant credit card is your home. They normally occur as a second mortgage on a house. The best use for a HELOC is often for temporary needs such as non long-term things like financial help for a small business, paying for college housing and tuition, paying off credit card debt and what seems to be the most popular for a HELOC, home remodeling. Others use a HELOC as an emergency fund for unforseen events that would require extra money.
One of the benefits of a HELOC is that lending fees are normally lower than those of conventional loans. For example, a HELOC can cost anywhere from 0.5% to 1.0% of the credit line. Sometimes, those fees can even be waived altogether, depending on your lender. This is attractive, considering that for a conventional loan, fees can cost anywhere from 2.0% to 5.0% of the total amount of your loan.
Many HELOCs have a time frame known as a draw period. This period of time can be usually be anywhere from 3-10 yrs. This time period is when you can get cash against the creidt line. Also during this time, a borrower usually only is required to make interest-only payments. Once the draw period is finished, the loan goes into what is called the repayment period. This time period usually last longer and can even be as long as twenty years. The montly payment of the borrower during this time will be taken from the balance at the end of the draw period and include the current interest rate. Nevertheless, there are some HELOCs that require that the person borrowing pays the entire loan at the end of a draw period. It is important if you are considering a HELOC that you make sure that the draw period is clearly defined as well as the repayment period.
Now for another acronym, an ARM, or adjustable rate mortgage. A HELOC is an ARM, sounds kinda funny, but this just means that the interest rate on your HELOC is dependent on the rise and fall of the current prime rate. A change in the prime rate can affect your HELOC for good or bad as soon as the next month. It is possible to find a fixed rate HELOC, but most are not fixed introductory rates. Even if you have a fixed rate HELOC, it may only be set for a certain amount of time such as a few months. Another vital thing to know as well is that a home equity line of credit doesn’t have a rate-increase cap like a normal loan usually does. It is for this reason that many refer to a HELOC as a giant credit card, because the interest rate can reflect that of a credit card interest rate if interest rates increase.
In summary, there are three things you need to make certain are clear to you before you try a HELOC, they are:
Fixed Intro Rate – Find out if you have a fixed rate HELOC and how long it lasts.
Repayment Period – You should know when the repayment period begins and it’s length.
Draw Period – You should know how long you will be able to draw against the loan.
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