For many homeowners who are already able to take out a second mortgage, the Home Equity Line of Credit or HELOC is one of the better sources of funds for major or recurring expenditures such as college tuition, home repairs, vacations, and even as a standby cash pool should unemployment hit.
HELOCs are known to provide large cash amounts at lower interest rates, and with its home loan classification, the interest paid is tax deductible. The loan is made available to the borrower in the form of a credit line from which he can draw any amount up to the credit limit, at any time.
If you are in the market for credit, take time to consider if a home equity line is the right option for you. Shop around for the best rates from banks or lending institutions, and choose one which offers the lowest fees and upfront costs. To help you in making your decision, here are the four major stages in the HELOC process:
Phase 1 – Homeowner applies for a HELOC
To avail of a home equity credit line, the applicant must have accrued home equity. In simple terms, home equity is the figure you get when you deduct the amount still unpaid on your home mortgage from the current property value. As with any loan transaction, the bank will also look into the homeowner’s credit score and history, his capacity to pay the loan, and the debt-to-income ratio.
Phase 2 – Bank approves the loan and sets the HELOC limit
A standard procedure for the bank or lender in the HELOC process is to conduct an appraisal to determine the home’s current value. If the borrower meets all other qualifiers, the HELOC limit is then set depending on your creditworthiness and the amount you still owe on your home. Home equity lenders typically let a homeowner borrow up to 85% of the appraised property value less the outstanding debt.
Phase 3 – The HELOC Draw Period
Once the loan is closed and the limit set, the HELOC now enters a draw period. The draw period is usually a span of 5 to 10 years wherein during this time, the borrower can withdraw from the line any time he wishes or when the need arises. Withdrawals can be made using a checkbook or a credit card tied to the HELOC and provided by the bank or lending institution.
When an amount is drawn from the line, the borrower then starts to receive a monthly bill which states the minimum amount he should pay. Depending on the credit terms, the payment due could be the interest only. The HELOC interest rate is based on the prime rate plus bank margin, and this varies from month to month.
Phase 4 – The HELOC Repayment Period
Following the draw period, the HELOC enters the repayment period, which is another 10 to 20 years where the borrower will no longer be able to make any withdrawals even if the credit line has not been fully utilized. The total outstanding balance (total amount withdrawn plus interest) will now be divided over the number of months assigned as the repayment period and will be billed monthly until the end of the term.
While the steps are generally the same for most home equity lines, in some cases the repayment period is eliminated, making the total balance due at the end of the draw period.
Before entering into a HELOC agreement, make sure that the terms, rates, fees, and conditions to the loan transaction are explicitly stated beforehand. If anything is unclear to you, ask questions. This way, you avoid any unwanted surprises in the future.