Home Equity Line of Credit or most commonly referred to as "HELOC", refers to a loan in which the lender agrees to lend a maximum amount within an agreed time period.
A Home Equity Line of Credit in many ways is similar to a credit card. At closing you are assigned a specified credit limit that you may borrow up to.
A draw period usually lasts anywhere from 5 to 10 years and allows you to borrow HELOC funds whenever you feel the need; you're only required to pay back the amount you use plus any interest.There are two types of home equity loans: a fixed rate loan, or an adjustable rate line of credit.
The fixed rate home equity loan is attractive when you need the money immediately. This type of loan gives you protection against rising interest rates. They typically take the form of a fifteen year fixed rate, or a thirty year amortization with any outstanding balance due after fifteen years.
A home equity line of credit, on the other hand, is attractive if you do not need the money right away. You only pay interest on the amount outstanding. Therefore, if there is no balance, there are no payments. When there is a balance, the lender typically requires that you only pay the interest due. The lenders typically let you draw on the line for up to twenty years, and then require you to pay back principal after the draw period has expired.
Some HELOC'S have minimum draws at close. This means that you will have to take a minimum cash out amount at close. Be sure to ask your mortgage broker if your HELOC has a minimum draw at close.
Most HELOC's, Home Equity Lines Of Credit, have an adjustable interest rate that is tied to a certain index. Some examples of indexes are: Libor, Prime, Cofi, MTA, etc... The rate will usually be index + the margin. The margin is usually based on the loan scenario, your credit scores, your LTV (loan to value), and equity line amount. The better your situation and the better the loan looks, usually the lower your margin will be. An example might be: if you were only borrowing a 30k home equity line, you have a home that is worth $300,000, you only owe 100k on your first loan, and your credit score is over 750 you may qualify for a loan that is prime + 0 for the margin. This means that your loan interest rate will always be equal to whatever Prime is. Now for the same situation, but with a 650 credit score and a 200,000 balance on your first loan, your credit is worse and your loan to value is significantly higher, so you will probably have a higher margin on your equity line: something like prime + 3.5% for your margin. Therefore you interest rate will always move up or down with Prime plus the 3.5%.
An advantage to opening a home equity line of credit even when not in need is to lock in the ability to tap into the equity built in the house. If the value of the home should decline, rather than losing financial power due to shrinking equity in the house, the homeowner would still have the full financial power to use the line of credit, which was opened when the home value was higher.
Many homeowners actually originate a home equity line of credit even when they have no immediate need for money. The beauty of this program is that you do not pay any interest on the equity line until you actually draw the funds. Having the HELOC can serve as a savings account of sorts or "rainy day" money if you will. It allows homeowners quick access to cash should ever a need arise.
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