Harmful Home Equity Practices
You could lose your home and your money if you borrow from unscrupulous lenders who offer you a high-cost loan based on the equity you have in your home. Certain lenders target homeowners who are older or who have low incomes or credit problems and then try to take advantage of them by using deceptive, unfair, or other unlawful practices. Be on the lookout for:
- Loan Flipping: The lender encourages you to repeatedly refinance the loan and often, to borrow more money. Each time you refinance, you pay additional fees and interest points. That increases your debt.
- Insurance Packing: The lender adds credit insurance, or other insurance products that you may not need to your loan.
- Bait and Switch: The lender offers one set of loan terms when you apply, then pressures you to accept higher charges when you sign to complete the transaction.
- Equity Stripping: The lender gives you a loan based on the equity in your home, not on your ability to repay. If you cant make the payments, you could end up losing your home.
How To Calculate Home Equity Line Of Credit
Wondering how to calculate how much you can obtain in funding through a HELOC? Heres how:
Step 1: Multiply your homes value times the percentage value that your lender allows you to borrow. This is the maximum equity that can be borrowed.
Step 2: Subtract the remaining mortgage balance from the maximum equity that can be borrowed This is the total amount you can borrow.
For example, say you get a HELOC with an 80% loan-to-value ratio. Your home is worth $300,000 and you currently owe $150,000. To figure out how much your credit limit would be on this HELOC, multiply your homes value by 80% and subtract your current balance.
$300,000 X .80 = $240,000
$240,000 $150,000 = $90,000
Under the terms of this scenario, you could potentially apply for a credit limit of up to $90,000.
Draw And Repayment Periods
HELOC terms have two parts. The first is a draw period, while the second is a repayment period. The draw period, during which you can withdraw funds, might last 10 years, and the repayment period might last another 20 years, making the HELOC a 30-year loan. Once the draw period ends, you cannot borrow any more money.
During the HELOCs draw period, you still have to make payments, which are typically interest-only. As a result, the payments during the draw period tend to be small. However, the payments become substantially higher in the repayment period since the principal amount borrowed is now included in the payment schedule along with interest.
It’s important to note the transition from interest-only payments to full, principal-and-interest payments can be quite a shock, and borrowers need to budget for those increased monthly payments.
Payments must be made on a HELOC during its draw period, which usually amounts to just the interest.
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How A Home Equity Loan Works
Essentially, a home equity loan is akin to a mortgage, hence the name second mortgage. The equity in the home serves as collateral for the lender. The amount a homeowner is allowed to borrow will be partially based on a combined loan-to-value ratio of 80% to 90% of the homes appraised value. Of course, the amount of the loan and the rate of interest charged also depend on the borrowers and payment history.
Mortgage lending discrimination is illegal. If you think you’ve been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development .
Traditional home equity loans have a set repayment term, just like conventional mortgages. The borrower makes regular, fixed payments covering both principal and interest. As with any mortgage, if the loan is not paid off, the home could be sold to satisfy the remaining debt.
A home equity loan can be a good way to convert the equity youve built up in your home into cash, especially if you invest that cash in home renovations that increase the value of your home. However, always remember that youre putting your home on the lineif real estate values decrease, you could end up owing more than your home is worth.
How Your Homes Equity Can Make It Happen
Want lower rates? Put away the credit card and tap into your HELOC.
Only borrow what you need. It replenishes as you repay itand you choose fixed or variable rates.2
It takes minutes to apply and decisions are quick. Plus, a dedicated loan officer will be there to answer all your questions.
When you use it for home improvements, the interest you pay could be tax-deductible.3
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Helocs Vs Traditional Loans
When you take out a traditional loan, you typically receive a lump-sum payment immediately after the appropriate paperwork is signed and processed. With a HELOC, however, you don’t receive a lump-sum payment. Rather, your lender provides you with a line of credit from which you can access funds on an as-needed basis during the HELOC’s draw period.
Understand Your Outstanding Balance At The Start Of The Repayment Period
Knowing the full amount helps you avoid surprises. You can budget your expenditures in a planned manner prioritizing important things for the next 10 to 20 years.
If you have a variable-rate loan, its best to start paying off your balance even before the beginning of your repayment period. Or, if youre looking for more financial stability, you may want to refinance with a fixed-rate loan.
How To Get A Home Equity Line Of Credit
The process of getting a HELOC is similar to that of a purchase or refinance mortgage. Youll provide some of the same documentation and demonstrate that youre creditworthy. Here are the steps youll follow:
Determine whether you have sufficient equity, using a HELOC calculator.
Once you have an idea of what you can borrow, shop HELOC lenders.
Gather the necessary documentation before you apply so the process will go smoothly.
Once you have pulled together your documentation and selected a lender, apply for the HELOC.
Youll receive disclosure documents. Read them carefully and ask the lender questions. Make sure the HELOC will fit your needs. For example, does it require you to borrow thousands of dollars upfront ? Do you have to open a separate bank account to get the best rate on the HELOC?
The underwriting process can take hours to weeks, and may involve getting an appraisal to confirm the home’s value.
The final step is the loan closing, when you sign paperwork and the line of credit becomes available.
Home Equity Loan Vs Heloc: An Overview
Home equity loans and home equity lines of credit are loans that are secured by a borrower’s home. A borrower can take out an equity loan or credit line if they have equity in their home. Equity is the difference between what is owed on the mortgage loan and the home’s current market value. In other words, if a borrower has paid down their mortgage loan to the point where the value of the home exceeds the outstanding loan balance, the borrower can borrow a percentage of that difference or equity.
Home equity loans give the borrower a lump sum upfront for which to spend, and in return, they must make fixed payments over the life of the loan. Home equity loans also have a fixed interest rate. Conversely, home equity lines of credit are credit lines that allow a borrower to tap into as needed up to a certain preset credit limit. HELOCs have a variable interest rate, and the payments are not usually fixed.
Both home equity loans and equity lines of credit allow consumers to gain access to funds that can be used for various purposes, including consolidating debt and making home improvements. However, there are distinct differences between home equity loans and equity lines of credit.
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Ask Your Loan Lender Some Pertinent Questions
If you have any doubts regarding your loan, its a good idea to reach out to your lender before you enter the repayment phase. Ask them some crucial questions, such as:
- Can I anticipate any change in the interest rate during the repayment phase?
- Do I have a fixed or a variable interest rate? Will I be able to shift to a fixed rate?
- What will be my monthly payment during the draw period and during the repayment period?
A good, reliable lender will notify you at least six months before the HELOC draw period ends and the repayment phase begins.
Interest Rate On A Home Equity Line Of Credit
- HELOC rates are always variable
- Because they are tied to the prime rate
- To figure out your interest rate
- Simply add up your margin and the current prime rate
Now lets talk about mortgage rates. A HELOCs interest rate is determined by the prime rate plus the margin designated by the bank or lender.
The margin, which can vary from bank to bank, is typically fixed throughout the loan term.
And as you may already know, the prime rate is variable and can change whenever the Fed makes a monetary policy decision.
Many banks will offer HELOC rates to borrowers at the prime rate with zero margin, or even less than prime, at least initially.
Youll often see bank ads that say prime -1% or something to that effect. Of course, this is usually an introductory rate, and will often go up after the first few months or year once the rate discounts no longer apply.
When reviewing HELOC rates, youll likely see the annual percentage rate listed alongside it, along with the word variable, because as noted, its tied to prime, which can change whenever the Fed decides to raise or lower rates.
Like mortgage rates on a normal home loan, your credit history will come into play in determining your HELOC rate, so strive for excellent credit to obtain the lowest rate.
Your loan-to-value ratio is also quite important, so the more equity in your home, the better. Put simply, a lower LTV, or CLTV as its known if the HELOC is a second mortgage, is key to a low HELOC rate.
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Understand Your Loan Terms
Once youve applied, the lender will provide you with information about the terms of the HELOC. Be sure to go over them carefully and make note of any requirements of when and how you can withdraw cash, how your monthly payments will be structured, how much youll pay in fees and any other pertinent information.
Risks And Benefits Of A Heloc
HELOC loans are popular because their interest rates are lower than many other types of loans. HELOCs offer great flexibility since they let you borrow as much or as little as you want over a period of time. Moreover, most lenders do not charge closing costs for a HELOC, which reduces the upfront expenses of obtaining credit. And finally, the interest payments on a HELOC may be tax deductible in certain circumstances.
These numerous advantages also come with some significant risks. The variable rate of a HELOC means that the interest may fluctuate throughout your loan. The interest you’ll pay is most commonly based on a benchmark rate, usually the federal funds rate. If the benchmark rate increases, so does your monthly payment. The fine print of your loan agreement often includes a maximum possible rate keep in mind, however, that the size of your payments depends on how much you borrow as well as on the interest rate.
If you borrow too much or if interest rates increase more than you expected, your monthly HELOC payment could grow beyond your ability to pay. As with any loan, falling behind on your HELOC payments can damage your credit. In the worst-case scenario, your lender can foreclose on your home, since you will have put it up as collateral for the HELOC.
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Lump Sums Vs The Long Term
With a home equity loan, you get one lump sum, one time. This can be useful if you have a project with a fixed cost that you need to cover upfront, like if youre replacing your roof. If youre doing a single, expensive home improvement project , it might not make sense to get a HELOC, since youll only need the money once, rather than having to continually borrow it.
A HELOC, on the other hand, is great if you have longer-term borrowing needs. For example, say youve purchased an investment property that you want to do significant renovations on. This will likely be an ongoing process with a variety of different costs, and you may not know upfront how much youll need to borrow in total. In this case, getting a lump sum with a home equity loan wouldnt make as much sense as opening a HELOC.
How Often Can The Interest Rate Change On A Heloc
With a variable rate loan, the interest rate you pay will change periodically based on overall market conditions. How often this resets varies depending on the lender, so be sure to note how often your rate will change. Your lender may also offer a low introductory rate for a short time.
The interest rate you pay on a HELOC is often tied to the prime rate set by the nations major banks and influenced by the Federal Reserve. Your rate could change frequently, such as every month, or potentially stay the same for years.
Your HELOC will typically also have a maximum interest rate you can face, called a cap. Some HELOCs also have caps on how high your monthly payment can increase, and minimum interest rates you can pay if rates fall.
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Accessing Your Funds Once You Have Them
Your lender will provide you with options for accessing your funds. Most allow you to withdraw cash by using online bank transfer or a HELOC account card . If you get an account card, you can use it just like you would a debit card to purchase things or withdraw cash at an ATM. You also usually have a checkbook that goes along with the account.
Something to keep in mind is that there may be minimum draw requirements and fees. Your lender may also require an initial draw amount. But after that, you can take out as much or as little as you like. Also, says Cook: Most HELOCs charge a maintenance or annual fee regardless whether youre actively using a line of credit.
So go ahead and start paying for college, planning your new kitchen, paying off high-interest credit cards or designing your in-ground pool. But, doing your homework is important as well. Lender terms can vary widely, so fully understanding all the ins and outs of your HELOC before entering into an agreement can be very important to your financial situation.
Considering Alternatives To A Heloc
HELOCs are relatively complex loans, and you may want a simpler solution that reduces your exposure to changing rates. A home equity loan works much like a HELOC, except that the loan is at a fixed interest rate, which means your monthly payments wont change. Also, a home equity loan gives you a single lump sum instead of repeated withdrawals during the draw period. While this schedule offers less flexibility than a HELOC does, home equity loans are ideal if you already know how much you need to borrow. In addition, the predictable repayment schedule of a home equity loan can save you from the potential instability of HELOC payments.
If HELOC rates are too high for you, refinancing your mortgage for a higher loan amount may be a better alternative. In cash-out refinancing, you replace your current home loan with a new mortgage that borrows more than what you owe currently. Since there’s more than enough money to pay off your old loan, you receive the remainder in a lump sum. A cash-out refinance follows a fixed rate structure, which results in lower rates and a stable monthly payment. However, mortgage refinancing does come with higher closing costs and a longer approval process compared to a HELOC. Alternatively, some lenders have begun offering convertible fixed-rate HELOCs which behave like a hybrid between a HELOC and a home equity loan.
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About Heloc Draw Period
As the value of homes increases, their owners can take out loans against the equity theyve built up in their homes. If you are in need of cash then a quick, easy source of funding is Home equity lines of credit or HELOCs.
A HELOC can be used to pay for home improvements and repairs and also for purposes that arent home-related, such as college education.
If you have a home equity line of credit, you would probably know that your HELOC includes two main phases, which are the HELOC draw period and the HELOC repayment period.
These two periods last for up to 25 or 30 years. You should take stock of your outstanding balance and decide whether or not you can afford to repay it with your current interest rate before your HELOC draw period ends.