Guide to HELOC Loans in 2017

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Is the value of your home rising? Do you have at least 10 to 20% equity? Then you may be thinking about tapping some of your hard-earned money with a home equity line of credit, or HELOC. If so, please use this article as your guide to HELOC loans for 2017.

HELOC Loan Program Overview

A HELOC is a second mortgage that is very similar to a home equity loan. The difference is that you are not borrowing an exact, set lump of cash. You are instead getting a line of credit that you may draw from as you wish.

For instance, you might be approved for a $50,000 HELOC loan. But you might decide that right now you only need to pull out $10,000. This would leave you with $40,000 on your credit line that you can use later if you like. You also may pay off the loan as you like, and pull money out again as well, up to your approved line of credit. You can do this as many times as you wish. In many ways, a HELOC works exactly like a credit card, but your ‘credit line’ is your home’s equity.

It's a good year for home-owners to take out a HELOC loan as rates are low and closing costs are minimal, in most cases.

It’s a good year for home-owners to take out a HELOC loan as rates are low and closing costs are minimal, in most cases.

As with a home equity loan, a HELOC uses your home as the loan’s collateral. You can use the line of credit for many things – home renovations, paying off credit cards, or buying an investment property, for example.

A HELOC loan can be a good choice for you if you have equity you want to draw out, but you do not want to refinance your first mortgage. Refinancing a first mortgage is expensive, takes time, and isn’t a good choice if you have a low interest rate.

A major benefit of the HELOC over the other options is that you only will pay interest on the amount that you actually pull out of the line of credit. This can make it less costly over the long term than a home equity loan.

Your HELOC is subordinate to your first mortgage. If you do not pay, the lender on the first mortgage gets paid first. You do not usually need the permission of your first lien holder to get a HELOC loan. However, the HELOC lender will ask to review your first mortgage paperwork. They want to ensure that you will not have to pay the first mortgage in full if a second mortgage is put on the property; this is called an acceleration clause.

On taxes, the HELOC interest is tax deductible up to $100,000 if you are married filing jointly. You should however consult with a tax professional to determine what if any of your HELOC interest is tax deductible.

HELOC Loan Types

There are two types of HELOC:

  • Adjustable or variable rate: Your interest rate can be changed ad may increase. This can be on a monthly, semiannual or annual basis. It will fluctuate based upon future changes in the index rate the lender uses, such as LIBOR or the prime rate. Your payment each month is based upon the amount outstanding and the current interest rate. You will be paying down the balance bit by bit each month.
  • Interest only: The rate on this type of HELOC also can fluctuate. But you are paying only interest during the 5-10-year draw period. This keeps your payment low, but you are not paying down the principal until the draw period ends.

What Is a Home Equity Line of Credit?

How a Home Equity Line of Credit Works

Most HELOCs consist of a draw period and repayment period. The majority of HELOCs today are 20 or 30-year loans and have a 10-year draw period. If you have a 30-year HELOC loan and a 10-year draw, you cannot draw cash from the home equity line after 10 years pass. You then must pay down your balance in the next 20 years.

Be aware of some HELOCs that have a balloon payment at the end. This is a feature of some interest only HELOCs. You would then be required to pay a large lump sum payment at the end of the loan. For instance, if you have a 15 year, interest only HELOC line with a balance at the end of $25,000, you need to pay all of that at the end of the 15th year.

It is important for you to understand all of the risks of a home equity line before you sign the paperwork.

People who own their home today are most likely enjoying an increase in their equity position. Home prices are going up and homes are appreciating in value. This increases the equity that a home owner has in the home. It also means that the owner can pull some of that equity out of the property and do some remodeling.

One of the most popular instruments used today to do home remodels is a home equity line or credit, or HELOC. A HELOC loan is a second mortgage that you get while leaving the first mortgage in place. A HELOC is used to take equity out of the home up to a certain amount; the maximum amount varies by lender and by state. Some situations allow the home owner to pull up to 80% of the home’s value out, while others may allow 85% or 90%.

Home Equity Loan Versus a HELOC

The HELOC loan is a variable interest line of credit based upon the amount of equity in the home. The lender will give you a HELOC with a certain line of credit, such as $25,000. You can draw that money out of the property whenever you wish, either in small increments or all at once.

Checking the Current HELOC Interest Rates

Your interest rate will be based upon the underlying index rate. This could be the monthly or the six-month LIBOR, or the prime rate. On top of that, there will be a margin between 0-3.25%. Some HELOCs may feature a minimum interest rate; most home equity credit lines also have a ceiling rate that it cannot rise above

Some HELOC loans feature a low, intro interest rate; this is called a teaser rate. It may be lower than the current rate for your first mortgage.  But the rate will go up at the end of the introductory period. It then becomes an adjustable rate that can go up for the rest of the loan’s term.

What are Today’s HELOC Rates?

Generally, HELOCs offered by banks, credit unions and mortgage bankers offer quite low rates. We recommend that you contact at least three lenders when looking for a HELOC.

Loan to Value Requirement with HELOC Accounts

You have to have enough equity to support the combined LTV or loan to value of your first mortgage plus your HELOC. Most lenders allow a maximum combined loan to value of 80%.

Let’s say your property is worth $200,000. If the balance on your first mortgage is $100,000 and you get a $60,000 HELOC, your combined loan to value is 80%.

Most traditional lenders only allow an 80% LTV combined. Some states also have laws that limit your loan to value at 80%. Some HELOC lenders may allow 90% to 100%. It pays to shop around!

The most important part of a HELOC is your loan to value. You need to have a very good grasp of what your home is worth today before you even apply. You can review sites such as Zillow, Redfin and Realtor.com to get an idea of what your home is worth. When you make the application, the lender will order a new appraisal. This costs you money. So, it is very important to know up front what the home is likely worth so you know if it is even worth applying. When shopping lenders and brokers, don’t forget to ask them what the LTV requirement is for HELOCs.

Qualification

The guidelines you need to know prior to taking the steps to apply for a HELOC are similar to getting a first mortgage. The focus is on your credit, income and your debt to income ratios. In many instances, the bank or broker will have a minimum credit score for most HELOC programs, so discuss your statistics with the loan officer or bank representative before making plans or big commitments.

Home Equity Loans with Bad Credit Scores

Advantages and Disadvantages 

Should you get a home equity line of credit? Maybe! Here are some advantages and disadvantages:

HELOC Advantages

  • Lower rate and payment at first
  • Save money and time compared to refinancing your first mortgage
  • Draw out only the money you need – save interest
  • You can draw down the HELOC and repay as many times as you wish
  • Lower rate over loan’s life than a first mortgage usually
  • You can use the money for whatever you wish
  • Interest is usually tax deductible

HELOC Disadvantages

  • Your rate can go up
  • Payment can go up a lot when you have to start paying principal
  • Extra fees are common – check your paperwork carefully

What You Need to Remember When Considering a Home Equity Credit Line

The HELOC is the most popular type of second mortgage for good reason. But you should do your homework carefully to determine if it is the right financial tool for you. A HELOC loan can be great for getting a low interest loan for your home renovations, college education, or paying down debt. Just remember that the low rate and payment you have up front will not last. It is important to speak with a HELOC lender and tax adviser so you plan financially down the road so that you have the income to make your payments on a timely basis.

Find out why so many homeowners love HELOC loans.

Find out why so many homeowners love HELOC loans.

How Does an Interest Only HELOC Work?

A home equity line of credit or HELOC is a very convenient and flexible way to borrow the equity in your home. A HELOC can be a good financial decision if the loan is managed in a prudent way. If you do not do so, however, a HELOC can cause you financial headaches.

To help you to get an interest only HELOC loan and manage it well, we have prepared the following guide.

HELOC Parameters

A HELOC is flexible 2nd-mortgage with a fixed line of credit that draws upon the equity in your home. HELOCs usually have a variable interest rate, which is based upon a benchmark rate, such as the Fed funds rate, plus a margin of profit for the lender. When interest rates climb, your HELOC loan rates can go up.

Many HELOCs have an interest only payment period, which is typically for the 10-year initial draw period. You are paying only interest on this loan, and are not reducing the principal. Once the draw period is over, you usually are left with a 20 year, fully amortizing loan. At this time, you are paying both principal and interest. So, the interest only portion of the HELOC is only temporary.

You also can face a hike in interest rates as it is a variable rate. It is not possible to predict how or when these rises in rates will happen. It is possible for the monthly payment to become too much for you to handle. This can lower your credit score if you are late on payments. Or, you might even lose your home.

It is important to know what the maximum possible interest rate is on your HELOC loan. All HELOCs have a maximum rate, but if you are paying 5% and the maximum is 10%, your payment could go up massively in a rising rate market.

More About Interest Only HELOCs

It is worth exploring interest only HELOCs more as these financial products are popular and carry some risk. Most people like to get an interest only home equity line of credit because it is a low-cost way to borrow a lot of money. But in the longer run, this product can cause trouble.

As noted earlier, you will face higher payments once principal payments kick in. Some borrowers also may have to pay a balloon payment after 15 or 20 years. If you are not budgeting for these higher costs, you may have trouble keeping up with payments.

Another aspect is that the principal on the loan remains as long as you pay only interest. The longer you wait to pay on principal, the longer you will be paying interest.

These types of interest only loans got many home owners in trouble in the financial crash of 10 years ago. Interest rates rose, incomes fell, it came time to pay on principal, and many people found out they could not afford their home anymore.

Considerations on Home Equity Credit Lines

Many people like HELOCs because the initial interest rate may be low, and you are often paying only interest on the money, not principal. This type of loan can work well when you are in a low interest rate environment. It also works for home owners who are confident that they will be making more money in the future. For people who have a higher risk tolerance, an interest only HELOC can be a good move.

A HELOC loan can also be a good option if you are confident that you will be selling your home in the next few years.

However, for people whose financial situation is harder to predict, or those who do not like financial risk, a HELOC with interest only may not be the best choice.

There are other options that may work better for you. One is a home equity loan. This is a lump sum pay out of your equity at a fixed interest rate. The rate will be higher than a HELOC and certainly more than an interest only HELOC, but you know exactly what your payment will be every month and when the loan will be paid off.

Another option is a fixed rate HELOC. These are not as common but some mortgage lenders do offer them.

We are fans of interest only HELOCs when they are used for the right reasons. If you have a very good reason to get the loan, such as for major home improvements or a college education, getting this type of loan makes sense in many cases. It also works for people who are sure they will be earning a lot more in 10 years.

The problems come in when you use an interest only HELOC to pay for things that do not pay you back. If you are using your equity to pay for ‘toys’ that you cannot afford on your salary, this is a bad use of debt. Make sure you are using your equity for things that will pay you back a profit, such as investments or home improvements.

For some, a home equity loan may be a safer bet, as you know exactly what the payments will be and when the loan will be paid off. Remember, your home is your most important asset, and you never want to put it at risk.

References:  HELOCs Can Hurt You. (n.d.). Retrieved from http://www.investopedia.com/articles/mortgages-real-estate/11/helocs-can-hurt-you.asp and https://www.freeandclear.com/programs/how-home-equity-line-of-credit-heloc-works.htm

 

About Bryan Dornan

With over 20 years in the mortgage industry, Bryan Dornan has started several companies, such as the Lead Planet, Mortgage Lenders Plus and the Refi Guide. Mr. Dornan has written hundreds of finance related articles in an effort to promote home-ownership to consumers across the United States.