The Home Equity Line of Credit (HELOC) has become a popular financing vehicle for many homeowners with equity in their homes. The purpose of this article is to help the average homeowner make a better decision when deciding whether to procure a new HELOC or retire a present HELOC.
First, what is a Home Equity Line of Credit? It is simply a loan that is secured against someone’s home. Though it could be secured against any property owned by an individual, in this case we will assume that the loan is secured against the homeowner’s primary residence. Furthermore, there are three characteristics that are typical of a HELOC –
The HELOC is typically the second mortgage secured against a property. For example, you might obtain a first mortgage of $400,000 when you purchase the property but then borrow an extra $100,000 two years later. The first mortgage still exists. If the home had no mortgage, otherwise known as “free and clear,” the home equity line would actually be a first mortgage, but this is not typical.
The HELOC is typically an “open” line of credit. This means that the homeowner can actually use the mortgage as a source of funds like a checking account. For example, if the HELOC is procured for a loan amount of $100,000 and the homeowner has only used $50,000 of that $100,000, they can actually write a check for any amount up to $50,000. Of course, any amount they use will result in an interest charge. So, if the payment was $300 per month at $50,000, it would hypothetically become $600 per month at $100,000.
A typical second mortgage is a “closed-end” mortgage. That means you apply for a loan for the exact amount you are going to use. If it is $50,000, then you apply for $50,000. When the loan is subsequently paid down, the homeowner cannot access that additional equity without procuring a new mortgage.
A HELOC is typically an adjustable-rate mortgage. Though there are certainly plenty of fixed-rate HELOCs available, more often than not the HELOC obtained will adjust based upon changes in the prime lending rate. The prime lending rate is the rate charged by banks to their best customers. Depending upon the total loan amount versus the value of the home and the credit score and other borrower characteristics of the homeowner, the HELOC may adjust at prime plus zero to prime plus four percent.
For example, if the HELOC was set at the prime rate plus two percent and the prime rate is presently at 3.25% (the rate as of February 1, 2015), the HELOC rate would be –
3.25%
+2.00%
5.25%
If the balance were $100,000, then monthly interest would be –
$100,000
X 5.25%
$ 5,250 annually
$ 437.50 monthly
While this may seem like a large payment, keep in mind that a car financed at $30,000 for four years could have a payment of almost that much! In the next segment, we will investigate the decision of whether to procure or retire a Home Equity Line of Credit, whether someone is purchasing a home or someone is trying to access equity in a home they already own.
