Home Equity Loan & Home Equity Line of Credit (HELOC)

Home Equity Loan – A fixed amount loan paid in one lump sum where the amount loaned is based upon a percentage of the equity owned in a home. This type of loan is a Second Mortgage of one of the two following flavors: Fixed Rate Mortgage or Adjustable Rate Mortgage, and eligible for all the bells and whistles available to those types of mortgages.

Home Equity Line of Credit (HELOC) – A line of credit extended to the homeowner, again based upon the equity owned in the home, which can be borrowed as necessary up to a fixed amount.



The amount of home equity allowed to borrow against will typically be determined by subtracting the current amount due on the primary mortgage from the product of 80% (80% is the maximum percentage of the total equity owned in a home that many lenders allow to be borrowed, however, there are some Home Equity Loan and Home Equity Line of Credit providers that offer percentages both above and below this figure) of the current appraised value of the home. For example, a home valued at $100,000 with a $50,000 mortgage will be eligible for a $30,000 Home Equity Loan or Home Equity Line of Credit.

HELOC Value Sketch

Advantages:

  • Home Equity Line of Credit – Lending institution fees are typically low when compared to a Fixed Rate Mortgage or Adjustable Rate Mortgage fees.
  • Home Equity Loan & Home Equity Line of Credit – Interest may be tax deductible. Discuss this with an accountant as the deduction allowed is not unlimited and is particular to your individual circumstance.
  • Home Equity Line of Credit – The period of time allowed for withdrawal from the credit line varies between loan institutions. This is also true for the credit line balance repayment period.

Disadvantages:

  • Home Equity Line of Credit – Most Home Equity Lines of Credit have high interest rate caps.
  • Home Equity Line of Credit – High exposure to interest rate fluctuations because HELOC interest rates are tied directly to the Federal Funds Rate which, at times, can by much more volatile than the majority of index’s an Adjustable Rate Mortgage can be pegged to.
  • Home Equity Line of Credit – Some HELOC’s require complete repayment at the end of the withdrawal period.
  • Home Equity Line of Credit – Beware of low introductory interest rates with large post intro interest rate adjustments.

Before You Sign – What to watch out for:

  • Use this Mortgage Shopping Worksheet, provided by the United States Federal Reserve Board, to compare different ARM’s from the same lender, ARM’s from different lenders, or to compare a Fixed Rate Mortgage to an Adjustable Rate Mortgage. This form will give you a detailed view of the cost of differing types of loans both now, and in the future.
  • A quick question to weed out the bad guys: When a lender or broker quotes a suspiciously low initial interest rate and payment on a loan, ask them for the annual percentage rate (APR). An APR that is considerably higher than the quoted initial interest rate will generally mean that your loan payments will increase significantly at the adjustment period, even if interest rates remain the same. This low initial interest rate is called a “teaser rate”.
  • Ask your lender, Mortgage broker, or Title officer for a copy of your Balance Sheet, Closing Statement, or Settlement Cost Sheet. (This document is called many different things by different institutions; use any of these terms and your lender, broker, or title officer should understand what you’re looking for.) By law, a borrower is entitled to review the settlement cost sheet one business day before closing on the loan – You absolutely must exercise this right and ask questions if you find something you don’t understand! Please follow the link above to find out what should be included in this document and why it matters to you.
  • Lenders must provide you with written information regarding the ARM mortgages that you are interested in. This information must include:
  • Loan terms & conditions
  • The name of the Interest Rate Index that the ARM is based upon
  • The margin added to the index by the lender or broker – profit
  • How the interest rate is calculated
  • The period of the interest rate change
  • Limits on the changes
  • An example of how high your monthly payments can become
  • An explanation of how negative amortization may effect you loan
  • Not all adjustable rate mortgages are set up to adjust downward – ask your broker or lender about this stipulation, especially if you’re shopping for a mortgage during a high interest rate period
  • Check introductory rates and periods. Ask your lender to map the loan out precisely in a fashion you understand.
  • Check for and ask about prepayment penalties
  • Verify account maintenance fees and/or servicing fees before signing.
  • Ask your lender, broker, or Title officer for an accounting estimate of all up-front fees you will be charged. These charges may come from the lender, title company, other third party, etc.
  • Interest Only Mortgage Options – Understand when principal will begin to be added to your monthly payments.
  • Balloon Mortgage Options – Understand exactly when the balloon payment will be due.
  • Construction Mortgage – to avoid an unexpected set of second closing costs, Verify whether your Construction Mortgage has one or two closings (see Construction Mortgage above).
  • A couple minor additional costs not included on the preliminary closing statement due to last minute unforeseen charges and exact interest calculations should be expected. These costs should be very small and typically not amount to more than a couple hundred dollars.

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We are not mortgage professionals nor do we claim to be. All information on this site is provided for informational purposes only. Individuals should always consult a real estate attorney prior to making any real estate commitments which they may not understand.