A home equity line of credit or HELOC is likened to a credit card—and some lenders actually give borrowers one. It’s a revolving credit line that allows you to borrow as much as you need whenever you need it by writing a check or using the credit card linked to your loan. Just like a credit card, you are given a maximum credit limit (the amount of your loan) so you only pay the amount you actually used. Thus, if you have a credit line of $100,000 but you only used up $20,000 you only need to pay the $20,000 together with the interest.
Just like a home equity line of credit, your loan is secured by your home. If you don’t pay it off, you may be forced to sell your house to pay off what you owe. Again, this requires advance planning and a rock solid repayment plan from your end.
While you can borrow up to 85 percent of the appraised value of your home as in a home equity loan minus the amount of your first mortgage, a HELOC is different because you need to consider many things before you sign the contract.
Ask the lender if there will be minimum and maximum withdrawal limits for your HELOC and if there is a so-called draw period. The latter refers to the time when you can get money from your account. When the draw period is up, you won’t be able to borrow any more money from your credit line unless you can renew your loan. Now here’s the catch: When the property values dropped significantly in 2008, banks no longer renewed the HELOC of borrowers, leaving those who were looking to refinance as a way to pay for their loan with a very heavy debt burden. This is one risk that HELOC borrowers have to take.
Before taking out a HELOC, be sure that you get a clear idea of what your interest will be and how it is structured. There are different interest rates for these plans and you need to certain that you know when it will go up and whether you can afford to pay for it when it does. Many HELOCs have variable interest rates wherein you get to pay a very small amount in the first few months—even at a steeply discounted rate—and then goes up to the real market value for the rest of the repayment period. Be sure to on the periodic and lifetime caps of the loan so you can determine if you will still be able to pay it off in case the rate surges. There are also other lenders that are amenable to allowing you to pay very small monthly payments over the life of your loan and then make a balloon payment to pay off the balance afterwards. This kind of arrangement is risky and you’d want to avoid it as much as possible.
Now if you can find a HELOC with a fixed interest rate and has reasonable terms overall then by all means go for it even if the monthly payments are higher. The plus is that you are assured that you will be paying the same amount over the life if your loan.
As in a home equity loan, be sure to negotiate the closing costs and other fees. With HELOCs, you might also have to pay continuing costs such as an annual membership fee and a transaction fee. Be sure to read the contract carefully before affixing your signature so that you are clear on the terms. You are still covered under the three-day cancellation rule if you do decide to rescind the contract for whatever reason.
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