Home Equity Line of Credit-The Basics
One type of home equity loan is a Home Equity Line of Credit (HELOC). In this type of loan, you as the homeowner have more control over things like the amount of money you borrow and the length of the repayment schedule than you would in a typical home equity loan. The most helpful way to think of a HELOC is as a credit line, rather than a home equity loan where you get one big sum of money at once. But, just like a home equity loan, your house serves as collateral for the HELOC. A home equity loan is also known as a closed-end loan meaning that the lender has loaned the homeowner the maximum possible for that client's credit history and home equity standing, whereas the HELOC is sometime referred to as an open ended loan since you pick how much money and how often you want to borrow from your equity and how long you will have to repay. When choosing this amount, it has to be within the parameters and limits set by your lender. These limitations are based upon the same criteria used for a regular home equity loan.
Some Advantages and Disadvantages of a Home Equity Line of Credit
A HELOC may give you the capability to deal with emergencies and finance major milestones in life such as a wedding or college. There are no rules or guidelines about what you can or cannot use the money for. Some people choose to pay off credit cards with high interest rates or to do remodeling or some type of home improvement. The nice thing about a HELOC is that you only pay interest on the amount of credit you use, not on the total available credit amount.
Another nice feature of a HELOC is that you may be able to simply pay the interest on the principal amount until the end of the term of the loan, also known as the end of the draw period. When the draw period is over, depending on your lender's terms of repayment, you will have three options. You can be required to pay back the full amount of the loan, or you may have to make a balloon payment, or go on a loan amortization plan. One more added bonus of this type of loan is that in some cases, the interest is tax deductible for federal and state taxes.
The biggest drawback of a HELOC is that most lenders will only offer you a variable interest rate on the loan. This means that the rate will most likely increase. Your credit rating at the time of the loan and the terms has a great impact on this. The other drawback is that if you opt to just pay the interest and don't pay down the principal of the loan, you will end up with a huge lump sum repayment at the end of the draw period. A HELOC can be a great financial tool, but you must use it carefully to safeguard yourself from foreclosure.
Tips on Finding a Lender
Look for a lender that offers a rate-cap on the variable interest rate. Consider an organization whose APR is close to the prime rate, since the prime rate changes every quarter, look for a lender that follows suit. Find a lender that adjusts rates in increments of 0.5% or less, so that your interest rate won't take a huge jump at once; also see if they will allow you to convert your HELOC into a home equity loan if interest rates get too high. Another thing to be aware of is the practice of charging superfluous fees such as account maintenance fees, appraisal fees, closing fees, usage fees, or even fees for writing checks. The best sort of lender will make money on the interest accrued rather than excessive and creative fees.
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