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A home equity line of credit aka HELOC is a loan in which the lender agrees to lend a borrower maximum amount, to be repaid within an agreed period or term. The collateral is the borrower's equity in their house.
Think of a HELOC loan as being similar to using a credit card. Here, your lender will decide upon a maximum loan amount and you can take out as much money as you need — until you reach the limit. And, you make monthly repayments to pay back your loan. But the good news is that the interest rate on a HELOC is far lower than it is on a credit card. You can borrow up to 85% of the value of your home minus the amount you own.
Here’s the simple math:
Suppose you have a $600,000 home with $400,000 balance on your first mortgage and your lender gives you access to up to 85% of your home’s equity. Your HELOC limit will come out to be $110,000.
$600,000 x 85% = $510,000
$510,000 – $400,000 = $110,000
If you’re a responsible homeowner with equity available against your house, a home equity line of credit is best for you. It can provide you with secured financing options with lower interest rates. The flexible draw period gives you the ease of paying back the loan as and when you desire.
Fixed time during which you can access funds from your home equity line of credit. It is typically for 10 years plus 1 month from the date you open the account. Your annual percentage rate (APR) during the draw period is variable and tied to the Prime Rate (PR). Unless you choose to take a fixed-rate advance. In which case, the payment is more predictable and stable.
End of draw
The date on which your draw period ends and you can no longer access funds from your home equity line of credit.
After your draw period ends, the repayment period begins. No additional funds can be borrowed and the balance must be paid off over the remaining term. You may keep the same payment structure as that of the draw period — principal-plus-interest payment, at variable rate.
To qualify for a HELOC, you need to have available equity in your home. The amount you owe against your home must be less than the actual value of your home.A lender generally looks at a few aspects of a borrower before sanctioning HELOC:
18 or above
Record of timely repayments in the past
Legal US resident
A permanent job with a steady source of income
Verifiable account with a reputed bank
A low debt-to-income ratio of 43%, or possibly up to 50%
620 or higher (300-575:Poor, 580-669:fair, 670-739:good,740-799:very good, 800-850: exceptional)
The borrower can draw any amount of funds up to the credit limit. Typically, the funds are accessed via a check, but sometimes the creditor issues a credit card to use in order to draw funds.
A borrower can apply for a HELOC loan in addition to an existing mortgage. This is convenient when they do not want to refinance or pay off an existing mortgage. If the term of HELOC is 15 years, the draw period will be the initial 10 years. During the draw period, monthly repayments are usually interest-only payments. These will depend upon the outstanding balance and current interest rate. The borrower can always pay more than the monthly interest to reduce the balance. Word of caution: It can be tempting to have access to a large amount of money, but repaying the loan needs to be planned well. You don't want to find yourself in a soup by falling behind on your payments, right?
Variable interest rate
HELOC has variable rate loans that are tied to short-term interest rates such as the Prime Rate. The rate can change daily as short-term rates fluctuate, but can usually be set monthly. In some cases when borrowers have strong qualifications and good collateral, they can obtain rates below the PR.
Actual interest rate charged
The amount is typically PR plus a fixed margin of 1% or 2%. The actual rate depends on the terms of the HELOC, and the borrower’s qualifications.
Home equity line of credit term
A HELOC term can be from 10 to 30 years. As explained, the draw period will be less than the total term. During the draw period, the borrower can draw funds up to the credit limit as needed, and repay as desired.
Which means that if the balance is not paid off by the end of the term, the borrower will have to pay an amount equal to the outstanding balance and interest due as final payment.
Where by creditors may spread the payments over the remaining term -- after the draw period -- and require a monthly principal and interest payment. The monthly payments will be the amount needed to pay off the balance over the remaining period at the current interest rate, and the payment will adjust as interest rates change.