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6 Tips To Understanding The Home Equity Line Of Credit

The Home Equity Line of Credit (HELOC) is one of the more complicated loans. This loan is different from standard loans because the borrower can borrow money based on the value of their home. The factors that determine the amount a borrower receives are: how much a home is appraised for, the amount of equity the borrower has, and the loan-to-value ratio the lender provides the borrower with. In order to determine whether an HELOC is right for you, here are 6 tips to understanding the Home Equity Line of Credit:

  1. How does a HELOC work? The HELOC functions similarly to a credit card. The borrower is provided with a limit from the lender, then the borrower can withdraw up to that limit over a period of time known as the “draw phase.” They can do this through writing checks or using a credit card. And, just like with a credit card, the borrower can then pay back the amount they borrowed over time. Typically, a lender will want the borrower to only pay the interest from the loans during the “draw phase.” When a borrower looks at different HELOC’s, it is important that he or she check how long the “draw phase” is, as each lender will provide a different duration of time. And just like a person should be wise in how they use their credit card, it is important to be wise in how the money is spent from an HELOC.
  2. Is a HELOC the same as a Home Equity Loan? No, they are not the same. With a Home Equity Loan, the borrower borrows a certain amount of money at one particular time. In a HELOC, the borrower is given a limit on how much they can borrow, but he or she can withdraw up to the limit as they see fit. With a Home Equity Loan, there is a fixed monthly payment, with a standard interest rate. With a HELOC, typically there is not a fixed rate as the interest rates changes. Unfortunately, a HELOC does generally have higher interest rates than a Home Equity Loan. When looking at the interest of a HELOC, be sure to add both the “prime” and “margin” provided by the lender. This will equal the interest.
  3. How is a HELOC calculated? In order to calculate a HELOC, the lender needs to know the appraised value of the property and the balance of the mortgages. The lender would then use that information in addition to the loan-to-value ratio they allow, calculating a homeowner’s HELOC. For example, if the appraised value of a homeowner’s property is $600,000 and the balance of mortgages is equal to $400,000, with a loan-to-value ratio of 85%, the homeowner’s credit limit would be $110,000.
  4. What is the cost of having a HELOC? There are fees that are associated with having a HELOC. First, there are the closing costs. These costs are generally less than the closing costs of a typical mortgage, but they still add up. Then, there is generally a minimum amount you have to withdraw right after or during closing. Additional fees include an annual fee and a cancellation fee.
  5. Who can receive a HELOC? In order to be accepted for a HELOC, the homeowner needs to have a couple of things going for them. First, a homeowner should be in a position where they feel confident in being able to repay the HELOC. They will need to have a stable job with a decent income. Second, the homeowner will need to have good or excellent credit in order to qualify. And third, the homeowner’s home needs to be appraised by an appraiser to have credible information on the value of the home.
  6. What are the risks of using a HELOC? Just like any loan, a HELOC comes with risk. The worst-case situation of using a HELOC is the loss of a home in a foreclosure. This occurs if a person is unable to meet the payments of the HELOC. Every dollar borrowed in a HELOC decreases the equity of a home. As the debt is repaid, the equity of the home increases as well. By defaulting on a HELOC, a homeowner could risk a foreclosure.

If a HELOC is something you are interested in, you will need to talk to a loan officer. Just like you would with other loans, you should compare the variety of HELOC’s that are available. Every lender is required to provide a Good Faith Estimate (GFE). As you send your application to different providers, be sure to compare the GFE’s you receive. This will help you make a well-informed decision.

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