The benefits property owners enjoy by securing a Home Equity Line of Credit are undeniable. Also called a “HELOC,” homeowners use their home's equity as collateral when applying for one of the most flexible loan products available.
HELOC rates are variable, and you only pay for the portion of funds you borrow, making this an advantageous option for qualified borrowers to use for home improvements, debt consolidation, emergency funds, medical expenses, investment property, or a wedding or dream family vacation. Unlike many other loan products, a HELOC allows borrowers to withdraw funds over a specific timeframe (typically a ten-year draw period) and use the money at their discretion. When the draw period ends, the repayment period (up to 20 years) begins, and the line of credit is no longer available to use. It's also when the monthly installments to repay any outstanding balance start.
Although a Home Equity Line of Credit can be more cost-effective than unsecured loan options, borrowers sometimes become overly fixated on securing the lowest HELOC rates and forget the other important considerations.
One of the differences between a HELOC and a personal or home equity loan is the variable versus fixed rate. Variable HELOC rates are determined by an index that the lender uses, and the interest rate charged fluctuates monthly according to the index change. By contrast, home equity loans and unsecured personal loan products are fixed rate options.
Another important feature of a Home Equity Line of Credit, besides the variable HELOC rate, is the ability for borrowers to make interest-only monthly payments on the outstanding loan balance during the draw period. While paying interest-only equates to a lower monthly payment, you can always pay more and apply it to your principal balance. Remember, as you repay your balance, the line of credit becomes available to reuse during the draw period. A traditional fixed-rate product doesn't offer this type of flexibility; it requires you to borrow a lump sum upfront and has a fixed payment amount for the life of the loan.
While HELOC interest rates are an important facet of this borrowing solution, Home Equity Lines of Credit are unique. There are many things to keep in mind when considering this option. When it comes time to apply for a HELOC, consider more than just HELOC rates; consider the additional costs related to the application and loan process and what happens after you are approved.
It may be in a borrower’s best interest to dive into wide-reaching aspects of a Home Equity Line of Credit that looks beyond interest rates. If you plan to take out a HELOC, in addition to the HELOC rates, these are things to consider.
Homeowners who focus on the best HELOC rates may look past other costs that make another lender’s product more expensive. These are items to compare when applying for a HELOC.
Also called an “origination” fee, it’s not unusual for lenders to charge a nominal amount to cover processing an application. However, some large lending institutions ramp this fee up and turn a profit on your application.
Sometimes, this hidden cost can be waived by lenders who have a certified notary public on-site.
It’s essential for lenders to ensure the HELOC applicant owns the property and possesses adequate equity to secure the loan. Unpaid taxes, liens, and other issues can disqualify people from HELOC approval. Be vigilant about not getting overcharged for this necessary part of the process.
Real estate appraisal costs have become relatively static in recent years. Although they are necessary to determine equity, it may be prudent to verify you are only paying for their service and not being overcharged.
A HELOC requires a professional to review the documents for accuracy. These fees are sometimes hidden in the closing costs. Check the line-item breakdown and make sure you are not excessively charged.
A HELOC requires lenders to gather documentation and process the loan.
It’s crucial to look deeper than HELOC rates when borrowing.
When homeowners come across HELOC rates that seem too good to be true, it may be time to do more research. Promotional offers with zero to less than 1 percent APR (Annual Percentage Rate) for a specified time are similar to the introductory credit card specials. Once the introductory period ends, the rate will most likely increase. Find out what rate you can expect once the promotional period ends.
Sometimes, lower promotional rates are interest-only payments, meaning your payment doesn't decrease your principal. If you don't make extra payments to the principal, you will be responsible for a large loan amount at a higher rate when the draw period ends. To take advantage of lower rates and not be hit with a large loan amount at the end of your draw period, consider setting up auto payment for the minimum amount due plus extra allocated towards the principal. This will help pay down the principal balance, avoid late fees, and protect your credit score.
When comparing HELOC offers, always double-check the requirements included. Some introductory rates depend on establishing automatic loan payments within the lender's online banking service, enrolling in direct deposit, opening a new deposit account, taking a minimum advance on your line of credit at closing, or maintaining a certain HELOC balance for a specified amount of time. Be sure to perform due diligence and read all the fine print to find the best HELOC offer.
Most HELOC lenders use the Prime Rate as published in the Wall Street Journal as the index to determine the Home Equity Line of Credit rate. For example, Prime plus 1% or Prime minus .5%. Other index references may be used, but this is the most commonly used.
When the Prime Rate decreases — the monthly interest rate charged on the outstanding balance (the portion of the line used) is less. If the Prime Rate increases, the variable rate increases, and the monthly payment follow suit. A third scenario is that the Prime Rate remains the same month after month, which means the HELOC rate remains the same.
HELOC rates typically have a floor and a cap associated with the rate. The floor determines the lowest possible rate, and the cap determines the highest or maximum rate.
One of the distinguishing factors between a Home Equity Line of Credit and a Home Equity Loan revolves around how much money homeowners pay back. With a Home Equity Loan, borrowers receive a lump sum and promptly begin monthly payments. HELOCs, by contrast, offer flexible withdrawals that allow borrowers to only pay on the portion of the line used.
Some lenders offer a promotional or introductory HELOC rate (with an expiration date) when a minimum amount is withdrawn at closing. If you don't need to borrow this amount or don't need to use the funds right away, you'll be paying interest before you need to.
Typically, after 10 years, the draw period ends, and the repayment period begins. The repayment period is when the line becomes a loan and the time to repay the outstanding balance. Monthly payment amounts include principal plus interest over the repayment period, which can last up to 20 years. Keep in mind that the length of your repayment period can increase or decrease your monthly amount due significantly. Be sure to find out if there is a prepayment penalty for paying off your balance in full before the repayment term expires. If not, it's good to include extra principal payments to the monthly amount due.
Loan and line of credit applications are more straightforward to process than ever before. Much of the information to complete and approve a HELOC application can be accessed online or shared via a secure site.
Borrowers looking for a fast approval process and wanting to avoid processing delays would be wise to work with a community bank that makes local decisions and better understands the local real estate market. All of which results in a faster approval process and closing.
It's not unusual for people searching for the best HELOC rates to start online. Still, it's highly recommended and in a borrower's best interest to begin the process by speaking to a local lending professional.
Due to the complex nature of a borrower's unique financial situation, meeting with a local expert with your best interest in mind should be your first stop when shopping and applying for the best HELOC available.
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