UNDERSTANDING HOME EQUITY LINES OF CREDIT (HELOC)
Adapted from REALTOR.com
A home equity line of credit (HELOC) isn’t the easiest type of loan to understand.
And there are some misconceptions about HELOCs that can get homeowners in trouble, or deter them from using the loan at all. The following are some common myths about HELOC’s that will help you understand how they work:
Myth #1 – A HELOC is not a second mortgage
A HELOC is a second mortgage UNLESS you use it to refinance your first mortgage. A HELOC comes with a lot of paperwork and closing costs, although not as involved as those associated with your first mortgage. Just be clear about the terms—you are putting your house up as collateral in order to access a line of credit.
Myth #2 – Once I get a HELOC, the line of credit can’t be lowered
Your HELOC’s credit line is not a guarantee, even if you already have it. If your house value plummets and you lose equity, your lender has the right to modify the agreement to adjust for the drop in value. And if your credit score drops significantly, the lender can reduce your credit limit.
Myth #3 – My HELOC works as cash reserves
A HELOC is significantly different from cash reserves:
- You have a limited draw period in which to take out funds.
- The bank can change the agreement if conditions change.
- The bank can freeze or cut back your HELOC amount.
- You must pay interest on any funds you withdraw.
- Your HELOC will come with specific terms and conditions from your lender that you need to evaluate.
Myth #4 – I can pull out all available equity from my home
Most lenders do not offer 100% financing. A common loan-to-value (LTV) financing with a HELOC is 85% and other lenders may cap it at 70%. Each lender is different, and how much of a credit line you will have access to depends upon the terms of the HELOC given to you by your lender.
Remember that the more you draw from your home, the more you have to pay back, with interest.
Myth #5 – It won’t cost me anything, so I’ll get one just in case
A HELOC is not free. You will have closing costs, and while they are small compared to those for your primary mortgage, that doesn’t mean they’re cheap.
With most HELOCs, there is a minimum draw required at the closing. And there is often a certain average balance required, which requires you to pay something in interest each month. Most HELOCs come with an annual fee as well as a cancelation fee. These fees, while not large, should be considered. You should know how much you are paying to access your home equity.
In conclusion, a home equity line of credit is a valid option for generating extra funds, as long as you are aware of all the terms and conditions.
As always, consult with an experienced mortgage professional for questions about financing that involves your home. Don Kelly at Affiliated Mortgage is our preferred lender, and he will provide you with the correct information about all matters pertaining to home financing.