The HELOC has become a popular choice for refinancing and paying for home improvements, educational expenses, major family events and similar occasional heavy financial commitments.
Although the basic concept of the HELOC does not vary a great deal between banks (for example, it is almost invariably linked to the prime rate) there are significant differences in repayment terms and banking fees. Potential borrowers who know exactly the amount of money they need to raise and have a good understanding of what a HELOC involves are well positioned to make a choice that could yield them substantial savings.
So what are the key points to consider when investigating HELOC deals?
Investigate repayment terms
HELOC repayment terms should be carefully considered. While some banks require paying back both the interest and principal over a set term you can also find interest-only HELOCs. You may be tempted by the lower monthly repayments of an interest-only HELOC but when the period of the loan expires you must pay it back as a lump sum. If you cannot easily refinance, your house will have to be sold.
Another repayment feature to watch out for is the minimum draw at closing. This forces the customer to borrow and start paying interest on a certain amount immediately. If this entire amount is not yet needed, you are effectively being forced to pay interest on money you do not yet require.
Cutting down the margins
For the typical borrower, one of the most crucial of the differences between the HELOC providers is the margin they add onto the prime rate to cover the risk on the loan and their profit needs. While banks state that the HELOC is going to be based on the prime rate, the margin they add onto this rate is not usually volunteered. It is quite possible that this margin might exceed the prime rate. For example, if a prime rate of 4% makes the HELOC sound a good proposition, remember that once the bank’s margin is added on, the amount you have to pay may be at least doubled. There is everything to gain from inquiring and comparing the margins between different HELOC offerings.
Contrary to what some people believe, the Federal Truth in Lending Act of 1968 (TILA) does not force banks to disclose their margins. A simple inquiry is unlikely to be sufficient to extract the full details. You cannot necessarily assume that the difference between the HELOC start rate and the prime rate represents the margin. Often margins are not standard for every borrower but vary according to their amount of equity and credit score and other factors. It is normal commercial practice for banks to quote their best deal margin but you might not qualify for this rate.
Banks often offer an attractive fixed guaranteed introductory interest rate on the HELOC. Sometimes this rate is only offered for the first month, but it is possible to find banks that offer an introductory rate for as long as six months.
A little too risky?
Given the fact that the borrower’s property serves as collateral for the HELOC, the risks involved are clearly going to be another major source of concern. A common difference between regular mortgages and HELOCs, is that the former are usually non-recourse loans. With a non-recourse loan the borrower’s personal liability for the loan ends if a foreclosure is executed on their property. This may or may not be the case with a HELOC and it is therefore important to qualify this point before deciding which bank to patronize.
Savings on fees
It is common for banks to charge an origination fee to cover their costs in processing loan application. Although some HELOC providers also charge such a fee, it is not difficult to find a HELOC lender who does not charge. Since origination fees can range from 0.5% to 2% of the value of the loan there is a clear gain in choosing a HELOC lender who does not require this payment.
Check writing fees can also be avoided by careful shopping around between the different lenders, and the same applies to the annual fee of $50 to $100 that some banks charge for keeping a credit line open.
Cancellation fees of up to $500 are also normally charged. Usually these fees are waived if the HELOC is maintained for at least three years but this should be verified in advance.