With my new fat mortgage, I’m considering whether to also take out a Home Equity Line of Credit (HELoC). This is not a home equity loan where you take out a lump sum at a fixed rate, but is a line of credit usually at a variable rate. I think of it as a credit card that is secured by my house (!). I don’t plan on actually using it, but I think it might nice to have around as long as the upfront costs to me are minimal. Here’s why:
Safety Net / Emergency Funds
Although having adequate emergency funds in cash is always preferable, it is nice to know that you have a HELOC as a backup in case of prolonged job loss or health problems. It’s always better to line up credit ahead of time while you have good credit rather than when you are already desperate. Using a HELOC can be preferable over paying sky-high credit card interest or falling behind bills (late fees, damaged credit score). Ironically, you might even use it to temporarily keep current on your mortgage to avoid penalties or even foreclosure. Let’s hope not.
Cheap and Flexible
The nice thing about a HELOC with no fees is that if you don’t take any money out, you don’t pay anything. And because the money is secured by your home, this assurance makes your interest rate relatively low. The rate is usually close to the WSJ Prime rate, which is currently 6% APR. On top of that, your interest paid might even be tax-deductible.
The interest is accrued daily, which makes it good for quick loans. So if you do need to take out $10,000 on short notice and you don’t have the cash on hand, using a HELOC might be the most economical way to do it. At 6%, your interest owed on $10,000 is only $1.64 a a day. Of course, for many folks this convenience might just provide too much temptation. All debt can turn into a double-edged sword. Know thyself, is all I can say.
Tool for Credit Card Profit Games
Here’s a trick to go along with making money with 0% balance transfers that is a good example of that flexibility. With certain credit card issuers it can be difficult to turn your balance transfer into cash in your pocket, especially when you have no existing balances. But here’s an example of how to use your HELOC to extract $10,000:
Request a balance transfer from your 0% APR credit card for $10,000 directly to your HELOC. Since this is loan they won’t mind at all.
Shortly before the balance transfer is scheduled to arrive, write a check for $10,000 from the HELOC to your interest-bearing bank account. Now you have created a temporary $10,000 debt at 6% and $10,000 bank balance earning ~4% (minus some possible lost days of interest).
When the balance transfer payment arrives a fews days to a week later, your HELOC debt will be paid off.
A week’s worth of interest at 6% APR ion $10,000 is only $11.50. And that is partially countered by interest earned in your savings account.
Voila! For around ten bucks, you now have $10,000 at 0% APR in your bank account to do as you wish.
Finding a HELOC - What To Look Out For
Now, I don’t want a home equity line if it’s going to cost me a bundle. Here’s a quick rundown of important factors when looking for a HELOC, based on an article by the Mortgage Professor.
Introductory rate and period. Temporary teaser rate to suck you in.
Margin. This is usually how your non-teaser interest rate is determined, relative to the Prime rate.
Minimum draw. How long can you take money out?
Required average balance. Do you have to take some money out?
Upfront lender fees. These days, you should be able to eliminate these.
Upfront third party fees. Harder to get waived, but try.
Annual fee. Just say no, again. Sometimes only waived for first year.
Cancellation fee. Many have these, I guess so you don’t bail and go to another bank. This is especially the case if they waive all the upfront costs above, since they are losing money on you so far. As long as you can keep your balance at $0 with no fees, just keep it open and don’t use it.
I see a lot of competition out there now that rates are low, so definitely shop around. As a data point, I just saw a special offer from Bank of America for a no closing cost, no application fee, no annual fee HELOC. Don’t forget to try your local credit unions as well.
Sunday, July 6, 2008
The difference between home equity loan and home line of credit.
Once you have built up equity in your home, you have the privilege of applying for a home equity line of credit, which allows you to borrow the money you need.
Most financial insititutions ( banks, savings and loans ) have entered the home equity market, so you have plenty of options when you shop for the best loan.
In effect, a home equity loan is a second mortgage on your home. You usually get a line of credit up to 70 percent or 80 percent of the appraised value of your home, minus whatever you still owe on your first mortgage.
For example, if your home is worth $100,000 and you owe $20,000 on your mortgage, you might receive a home equity line of credit for $60,000 because your lender would subtract your $20,000 owed on the first mortgage from your $80,000 worth of equity.
You will qualify for a loan not only on the value of your home but also on your creditworthiness. For instance you must prove that you have a regular source of income to repay a home equity loan.
The difference between the two kind of credits is easy: the home equity loan has a fixed rate and the home equity line of credit has a rate that fluctuate and it's better indicate to consolidate other debts than the credit cards.
The home equity line of credit is an " on demand" source of funds that you can access and pay back as needed.
You only pay interest if you carry a balance because these line of credits are essentially a revolving line of credit, like a credit card but with a much lower rate because the line of credit is secured by your home.
Like other mortgages, the home equity loan requires you to go through an elaborate process to qualify for an open line of credit. You will usually need a home appraisal and must pay legal and application fees and closing costs.
Because a home equity loan is backed by your home as collateral, it is considered more secure by lenders than unsecured debt, such as credit card debt. Further, because the loans are less risky for banks, you benefit by paying a much lower interest rate than you would on credit cards or most other kinds of loans.
Home equity loans can therefore offer extremely attractive rates when the prime interest rate is low, but subject you to much higher interest costs if the prime shoots up.
You can tap the credit line simply by writing a check, and you can pay back the loan as quickly or as slowly as you like, as long as you meet the minimum payment each month.
Most financial insititutions ( banks, savings and loans ) have entered the home equity market, so you have plenty of options when you shop for the best loan.
In effect, a home equity loan is a second mortgage on your home. You usually get a line of credit up to 70 percent or 80 percent of the appraised value of your home, minus whatever you still owe on your first mortgage.
For example, if your home is worth $100,000 and you owe $20,000 on your mortgage, you might receive a home equity line of credit for $60,000 because your lender would subtract your $20,000 owed on the first mortgage from your $80,000 worth of equity.
You will qualify for a loan not only on the value of your home but also on your creditworthiness. For instance you must prove that you have a regular source of income to repay a home equity loan.
The difference between the two kind of credits is easy: the home equity loan has a fixed rate and the home equity line of credit has a rate that fluctuate and it's better indicate to consolidate other debts than the credit cards.
The home equity line of credit is an " on demand" source of funds that you can access and pay back as needed.
You only pay interest if you carry a balance because these line of credits are essentially a revolving line of credit, like a credit card but with a much lower rate because the line of credit is secured by your home.
Like other mortgages, the home equity loan requires you to go through an elaborate process to qualify for an open line of credit. You will usually need a home appraisal and must pay legal and application fees and closing costs.
Because a home equity loan is backed by your home as collateral, it is considered more secure by lenders than unsecured debt, such as credit card debt. Further, because the loans are less risky for banks, you benefit by paying a much lower interest rate than you would on credit cards or most other kinds of loans.
Home equity loans can therefore offer extremely attractive rates when the prime interest rate is low, but subject you to much higher interest costs if the prime shoots up.
You can tap the credit line simply by writing a check, and you can pay back the loan as quickly or as slowly as you like, as long as you meet the minimum payment each month.
How A Home Equity Line Of Credit Can Help Your Finances
by Thomas Erikson -
A bag justness distinction of assign unlocks your home’s continuance so it crapper impact for you. Owning your bag crapper wage you with a business inventiveness that crapper support you with your business needs.
Since justness is the continuance of your bag harmful the remaining mortgage outstanding, you haw be movement on the change that you crapper ingest to meliorate your business situation, renew your bag or go on that pass you’ve ever dreamed of.
Why Would You Want a Home Equity Line of Credit?
A distinction of assign is not same a exemplary provide which provides a amass assets of money to you and then begins charging you welfare at a immobile appraise until repaid. Instead, it acts same revolving assign (much same your assign card). You exclusive ingest as such or as lowercase as you poverty and you exclusive clear welfare on the turn you hit used. Also, same a assign card, when the debt is repaid you ease hit admittance to the credit. In contrast, with a exemplary loan, you would be stipendiary welfare on the flooded turn of the loan. And when a provide is stipendiary off, you no individual hit that assign acquirable to you – you would hit to reapply for a newborn loan.
The essential feature of a bag justness distinction of assign is providing you greater plasticity at accessing assign with the small cost. Not exclusive crapper you admittance the assign exclusive as you requirement it, but your monthly payments emit exclusive the equilibrise you used. So the inferior you ingest of it, the modify your payment. Some lines of assign order you to exclusive the welfare as the peak payment. This feature crapper be adjuvant when assets are tight. (Be careful, it takes develop not to ingest this feature to render outlay habits).
A bag justness distinction of assign is enthusiastic when you don't hit a super immobile turn to clear in digit place. While you crapper encounter whatever uses for your distinction of credit, here are whatever more ordinary reasons for obtaining a bag justness distinction of credit.
Consolidate Debt
One of the more essential uses for your bag justness distinction of assign is to consolidate debt. You crapper decimate the pronounce of binary bills and also obtain a more approbatory welfare appraise or set benefit.
Second Mortgage
You haw become crossways a instance when you encounter your mortgage welfare appraise higher than your bag justness distinction of credit’s welfare rate. If that is the case, then using your distinction of assign to clear soured the existing mortgage for meliorate welfare rates makes sense.
Home Renovations, Additions
You haw ingest your distinction of assign for renovating or antiquity that newborn constituent to your home. You clear inferior welfare than you would if you utilised a assign bill and that makes it a owlish business choice.
When Should You Not Use a Home Equity Line of Credit?
Before making precipitous decisions with your newborn institute money source, it’s essential to appraise the added risk.
Some debts hit features that you haw not be entitled to if you alter them to an justness distinction of credit. A amend warning is your enrollee loans. They are person to primary conditions that if denaturized by you, crapper outlay you. You requirement to analyse into your enrollee provide cost and conditions before considering agitated them.
With the feature to clear exclusive the welfare you haw demand the requirement to clear soured the debt and modify up stipendiary exclusive the welfare for a daylong time. When this happens, you modify up owing for items that hit forfeited their continuance over time. It makes more business significance to refrain using your distinction of assign to acquire items that decrease and pore on items that module process in continuance naked time. Also, attain plans to clear soured the debt apace for the most advantage.
Lines of assign verify plus of underway baritone welfare rates which effectuation they are person to fluctuating welfare rates. If you requirement large finance that module verify a daylong instance to clear off, you haw encounter that lawful loans protect you better. A immobile appraise provide crapper wage example of nous lettered that your monthly payments are not feat to process as welfare rates go up.
Using your assets sagely crapper provide you enthusiastic comfort and freedom. Before attractive on some business obligations it is essential to see the risks as substantially as the benefits.
Thomas Erikson is co-founder of www.your-debt-consolidation-loan.com which provides home justness distinction of credit aggregation and solutions.
Article Directory: Article Dashboard
Summary : A bag justness distinction of assign unlocks your home’s continuance so it crapper impact for you. Owning your bag crapper wage you with a business inventiveness that crapper support you with your business needs. Since justness is the continuance of your bag harmful the remaining mortgage outstanding, you haw be movement on the change that you crapper ingest to meliorate your business situation, renew your bag or go on that pass you’ve ever dreamed of. Why Would You Want a Home Equity Line of Credit? A lin...
A bag justness distinction of assign unlocks your home’s continuance so it crapper impact for you. Owning your bag crapper wage you with a business inventiveness that crapper support you with your business needs.
Since justness is the continuance of your bag harmful the remaining mortgage outstanding, you haw be movement on the change that you crapper ingest to meliorate your business situation, renew your bag or go on that pass you’ve ever dreamed of.
Why Would You Want a Home Equity Line of Credit?
A distinction of assign is not same a exemplary provide which provides a amass assets of money to you and then begins charging you welfare at a immobile appraise until repaid. Instead, it acts same revolving assign (much same your assign card). You exclusive ingest as such or as lowercase as you poverty and you exclusive clear welfare on the turn you hit used. Also, same a assign card, when the debt is repaid you ease hit admittance to the credit. In contrast, with a exemplary loan, you would be stipendiary welfare on the flooded turn of the loan. And when a provide is stipendiary off, you no individual hit that assign acquirable to you – you would hit to reapply for a newborn loan.
The essential feature of a bag justness distinction of assign is providing you greater plasticity at accessing assign with the small cost. Not exclusive crapper you admittance the assign exclusive as you requirement it, but your monthly payments emit exclusive the equilibrise you used. So the inferior you ingest of it, the modify your payment. Some lines of assign order you to exclusive the welfare as the peak payment. This feature crapper be adjuvant when assets are tight. (Be careful, it takes develop not to ingest this feature to render outlay habits).
A bag justness distinction of assign is enthusiastic when you don't hit a super immobile turn to clear in digit place. While you crapper encounter whatever uses for your distinction of credit, here are whatever more ordinary reasons for obtaining a bag justness distinction of credit.
Consolidate Debt
One of the more essential uses for your bag justness distinction of assign is to consolidate debt. You crapper decimate the pronounce of binary bills and also obtain a more approbatory welfare appraise or set benefit.
Second Mortgage
You haw become crossways a instance when you encounter your mortgage welfare appraise higher than your bag justness distinction of credit’s welfare rate. If that is the case, then using your distinction of assign to clear soured the existing mortgage for meliorate welfare rates makes sense.
Home Renovations, Additions
You haw ingest your distinction of assign for renovating or antiquity that newborn constituent to your home. You clear inferior welfare than you would if you utilised a assign bill and that makes it a owlish business choice.
When Should You Not Use a Home Equity Line of Credit?
Before making precipitous decisions with your newborn institute money source, it’s essential to appraise the added risk.
Some debts hit features that you haw not be entitled to if you alter them to an justness distinction of credit. A amend warning is your enrollee loans. They are person to primary conditions that if denaturized by you, crapper outlay you. You requirement to analyse into your enrollee provide cost and conditions before considering agitated them.
With the feature to clear exclusive the welfare you haw demand the requirement to clear soured the debt and modify up stipendiary exclusive the welfare for a daylong time. When this happens, you modify up owing for items that hit forfeited their continuance over time. It makes more business significance to refrain using your distinction of assign to acquire items that decrease and pore on items that module process in continuance naked time. Also, attain plans to clear soured the debt apace for the most advantage.
Lines of assign verify plus of underway baritone welfare rates which effectuation they are person to fluctuating welfare rates. If you requirement large finance that module verify a daylong instance to clear off, you haw encounter that lawful loans protect you better. A immobile appraise provide crapper wage example of nous lettered that your monthly payments are not feat to process as welfare rates go up.
Using your assets sagely crapper provide you enthusiastic comfort and freedom. Before attractive on some business obligations it is essential to see the risks as substantially as the benefits.
Thomas Erikson is co-founder of www.your-debt-consolidation-loan.com which provides home justness distinction of credit aggregation and solutions.
Article Directory: Article Dashboard
Summary : A bag justness distinction of assign unlocks your home’s continuance so it crapper impact for you. Owning your bag crapper wage you with a business inventiveness that crapper support you with your business needs. Since justness is the continuance of your bag harmful the remaining mortgage outstanding, you haw be movement on the change that you crapper ingest to meliorate your business situation, renew your bag or go on that pass you’ve ever dreamed of. Why Would You Want a Home Equity Line of Credit? A lin...
Taking advantage of convertible home equity lines of credit
Home equity lines of credit (HELOCs) have lately been maligned with unsustainable mortgage equity withdrawal (MEW) financing such essentials as two-week long vacations, German-imported vehicles, requisite granite counter tops and travertine flooring; however, HELOCs are a useful and important financial vehicle available to home owners. Their importance escalates in times of tightening credit and stable/declining home values. In this three part series we examine some of the important features that home equity lines of credit offer to homeowners as part of a strategic home financing plan. We’ll examine the following three features in this series:
Convertible HELOCs
True no-cost HELOCs
Equity protection & repositioning
Today, we’ll look at the important role that convertible home equity lines of credit can play in helping reduce monthly mortgage payments as well as protect against the payment shock so often associated with adjustable rate mortgages. If you are a luxury property owner or a Realtor who services the luxury market-be sure to read to the end for my Two Gems of Convertible HELOCs that are just for you.
Home Equity Lines of Credit BASICS
Before we get in to the important features we need to first cover some basic ground for those that are not entirely familiar with home equity lines of credit. A HELOC is a loan secured by your home that differs from a traditional home loan in the following ways:
It is tied to the prime interest rate, which means the interest rate can fluctuate up and down as the prime rate changes. Prime is tied to the Fed Funds rate; which dictate the short-term interest rates available on debt such as HELOCs, credit cards, and other short-term debt.
HELOCs are made up of two parts, the “line amount” which is the amount of money that you can borrow on the HELOC; and the “draw amount” which is the amount of money you initially borrow when you open the HELOC.
You can withdraw money for a set period of time after opening the line (usually 10-15 years) at any point via a credit card or checks tied to your HELOC up to the approved line amount.
You only pay interest on the amount borrowed, regardless of the line amount. With a traditional mortgage you begin paying interest on the entire amount right away.
Your minimum monthly payments are initially calculated as interest only for the first ten years. This allows you to either pay down the line, or simply make the interest payments to keep the line in good standing.
HELOCs are usually based on a 25 year repayment term. The first 10 years are interest only, the remaining 15 years principal and interest are owed to pay off the line.
May be convertible to a fixed rate mortgage one or more times during the life of the loan term. A small fee may be charged to convert.
Home equity lines of credit are often used as an alternative to a second mortgage. In the industry we refer to them 2nd liens or being in “2nd position” to refer to their subordinate position to the primary “1st” mortgage. However, HELOCs can also be used in first position, as an alternative to first mortgage products.
Convertible Home Equity Lines of Credit
A convertible HELOC refers to a home equity line of credit product that can be converted from an adjustable rate HELOC in to a fixed-rate mortgage. While each bank offers a slightly different type of convertible product most have similar characteristics.
Can convert from HELOC tied to the ever-adjusting prime interest rate to a fixed-rate mortgage (typically 30-year fixed).
Can continue to use remaining credit available above and beyond the fixed amount.
Done over the phone with a customer service representative, the conversion goes in to effect immediately.
No additional qualifying is required. No underwriting, credit review or asset/income documentation needed.
A small fee (~$250) may or may not be charged for the conversion.
Multiple conversions may be allowed. Common conversion allowances are 1, 2, and 5 times.
Conversion is to the prevailing fixed interest rate available through the bank (or some rate based on the prevailing rate + a premium for conversion).
Questions to Ask Before Committing to a Convertible HELOC
Is there a charge for converting to a fixed-rate mortgage? What is that cost?
Is there an ability to continue to use the remaining credit available on the line after a conversion?
Is the conversion to a 30-year fixed term?
Is the payment on the converted line interest only or principle and interest?
How many times can I convert?
How often can I convert?
Some Typical Uses of Convertible HELOCs
Scenario 1
People use a convertible HELOC to complete a very specific project that may take time to accomplish. Consider a lengthy home improvement project. By taking a 2nd mortgage, you receive all the money from the financing immediately and begin paying interest on that amount from day one. This is not the most desirable outcome for a large-scale renovation or remodel. If you undertake a significant addition to your home you need time to go through the planning, permitting and specification phase of the project before building actually commences. This process often takes many months.
If you are planning on financing this upfront work with money from your home equity using a second mortgage would require you to pay interest on the full amount borrowed. With a HELOC you can draw little amounts at a time to pay for related expenses. Interest is only owed on the money borrowed.
In these types of situations a HELOC may save you money over the long run, as you are only charged interest on the money you borrow. However, once the project is complete and you anticipate no future withdrawals on your HELOC; converting to a fixed-rate allows you to keep your monthly payments fixed for the duration of the repayment period. This removes your exposure to jumps in the prime interest rate, and the concomitant increases in monthly payments.
Scenario 2
People also convert their HELOCs in to a fixed-rate loan once they’ve used the balance of their home equity line. Similar to the end state of scenario 1, once the HELOC is tapped out it makes sense to protect yourself from the exposure of rising interest rates. Converting the HELOC to a fixed-rate loan accomplishes that nicely.
Scenario 3
If interest rates begin to rise quickly and you have no current need for your equity line, converting to a fixed-rate loan can create dramatic monthly savings when compared to letting the interest rate float. This strategy makes sense usually under the following conditions:
You have multiple conversions available on your line.
You are able to continue to use the line after converting the currently-owed balance to a fixed-rate
If your line has these options, then converting the currently-owed balance to a fixed rate can provide you with stable monthly payments, while still maintaining access to your equity for future expenses.
Using the Convertible HELOC as a First Mortgage
Here is where convertible HELOCs get interesting; especially in a higher-rate environment like the one we are currently facing in the housing market. Let’s take the specific example of a home owner who maintains a property worth $1,000,000; a common scenario along the California coast. If they purchased the home within the last five years, or have refinanced in the last five years, they more-than-likely hold some type of jumbo, Alt-A 1st mortgage (or 1st and 2nd combo). Jumbo mortgages are anything over $417,000, the conforming limits for Fannie Mae and Freddie Mac purchase. Alt-A mortgages had low rates and loose qualifying guidelines during the past five years, making it easy for people owning expensive properties to find inexpensive financing. The mortgage market has changed dramatically in the last few months.
The current mortgage market for jumbo and Alt-A loans has been priced with a much higher premium to interest rate lately as the secondary mortgage market has balked at high-balance home loans. A jumbo loan in 2005 that was 6% is now 8% - a huge increase when considering the large loan amounts associated with high-end properties. On a million-dollar loan this change represents a 23% increase to the monthly payment. This has effectively locked high-end property owners out of the refinance or purchase markets.
It is especially painful to jumbo loan holders who are also in adjustable rate mortgages (ARMs) coming in to their adjustment period. Many Alt-A loans were mid-term ARMs with 3, 5 and 7 year terms. These loans face pricey payment adjustment schedules which can make a once affordable mortgage quickly unaffordable.
Here is where our friend the convertible HELOC comes in to play. Home owners facing the specter of an ARM reset in a jumbo loan can use the convertible HELOC in two ways to help reduce their mortgage payments. I call these the Two Gems of Convertible HELOCs.
Gem 1
Take the HELOC in first position as a 1st mortgage. Some convertible HELOCs convert to a much lower interest rate than their 1st mortgage jumbo competitors. Ask your mortgage professional what the going rate is on the converted loan and you may be surprised to find that it is nearly a full point lower than the going jumbo interest rate on the same loan. Continuing our $1,000,000 loan example from above; this 1% interest rate difference results in a 9% monthly payment savings. This savings can be the difference between affordable mortgage option and unaffordable mortgage option.
The reason this exists is that some HELOCs convert to the going 30-year fixed rate, regardless of other factors. Now this type of program is not available at every bank, if you can find a bank that does-you now have a viable jumbo loan alternative to the pricey 1st mortgage products available today.
This does carry some caveats. You must understand the conversion options, the rate that you’d be converting to, and any other limitations prior to signing on for the HELOC. Some banks make their conversions overly expensive to keep this type of financing from cannibalizing their jumbo loan financing pipeline. You also need to understand that you may have to carry the higher interest rate of the HELOC for a period of up to a week after signing loan documents. This requires that you have a very trusting relationship with the mortgage professional you work with; and that you verify all aspects of the HELOC documents carefully to ensure your conversion options match what you discussed during the loan process.
Gem 2
Instead of taking the whole loan balance as a 1st position HELOC, take a conforming 1st mortgage up to $417,000 and then take the remaining as a convertible HELOC. Once you sign the loan documents you can convert the HELOC to a fixed rate and achieve a blended interest rate (the effective interest rate of your 1st and 2nd mortgage combined) that can also be up to a point lower than the going jumbo loan rate.
In order to calculate the blended rate of the two mortgages use the following equations:
(1st Mortgage / Total Mortgage Amount) x 1st mortgage interest rate = Rate 1
(2nd Mortgage / Total Mortgage Amount) x 2nd mortgage interest rate = Rate 2
Rate 1 + Rate 2 = Blended Rate
An example:
1st Mortgage: $417,000
2nd Mortgage: $583,000
1st Mortgage rate: 6.5%
2nd Mortgage rate (after conversion): 8.5%
(417,000 / 1,000,000) x 6.5 = 2.71%
(583,000 / 1,000,000) x 8.5 = 4.96%
Blended rate: 7.67%
Conclusion
The convertible HELOC is an important financial tool for any homeowner; especially homeowners who are in jumbo loan products. As detailed in the example above a convertible HELOC can provide an avenue of lower-cost financing than the current Alt-A and jumbo loan markets currently offer. There are some definite caveats so it is important that you speak with a mortgage professional who can expertly match your current financing needs with the best combination of products available on the market today.
Convertible HELOCs
True no-cost HELOCs
Equity protection & repositioning
Today, we’ll look at the important role that convertible home equity lines of credit can play in helping reduce monthly mortgage payments as well as protect against the payment shock so often associated with adjustable rate mortgages. If you are a luxury property owner or a Realtor who services the luxury market-be sure to read to the end for my Two Gems of Convertible HELOCs that are just for you.
Home Equity Lines of Credit BASICS
Before we get in to the important features we need to first cover some basic ground for those that are not entirely familiar with home equity lines of credit. A HELOC is a loan secured by your home that differs from a traditional home loan in the following ways:
It is tied to the prime interest rate, which means the interest rate can fluctuate up and down as the prime rate changes. Prime is tied to the Fed Funds rate; which dictate the short-term interest rates available on debt such as HELOCs, credit cards, and other short-term debt.
HELOCs are made up of two parts, the “line amount” which is the amount of money that you can borrow on the HELOC; and the “draw amount” which is the amount of money you initially borrow when you open the HELOC.
You can withdraw money for a set period of time after opening the line (usually 10-15 years) at any point via a credit card or checks tied to your HELOC up to the approved line amount.
You only pay interest on the amount borrowed, regardless of the line amount. With a traditional mortgage you begin paying interest on the entire amount right away.
Your minimum monthly payments are initially calculated as interest only for the first ten years. This allows you to either pay down the line, or simply make the interest payments to keep the line in good standing.
HELOCs are usually based on a 25 year repayment term. The first 10 years are interest only, the remaining 15 years principal and interest are owed to pay off the line.
May be convertible to a fixed rate mortgage one or more times during the life of the loan term. A small fee may be charged to convert.
Home equity lines of credit are often used as an alternative to a second mortgage. In the industry we refer to them 2nd liens or being in “2nd position” to refer to their subordinate position to the primary “1st” mortgage. However, HELOCs can also be used in first position, as an alternative to first mortgage products.
Convertible Home Equity Lines of Credit
A convertible HELOC refers to a home equity line of credit product that can be converted from an adjustable rate HELOC in to a fixed-rate mortgage. While each bank offers a slightly different type of convertible product most have similar characteristics.
Can convert from HELOC tied to the ever-adjusting prime interest rate to a fixed-rate mortgage (typically 30-year fixed).
Can continue to use remaining credit available above and beyond the fixed amount.
Done over the phone with a customer service representative, the conversion goes in to effect immediately.
No additional qualifying is required. No underwriting, credit review or asset/income documentation needed.
A small fee (~$250) may or may not be charged for the conversion.
Multiple conversions may be allowed. Common conversion allowances are 1, 2, and 5 times.
Conversion is to the prevailing fixed interest rate available through the bank (or some rate based on the prevailing rate + a premium for conversion).
Questions to Ask Before Committing to a Convertible HELOC
Is there a charge for converting to a fixed-rate mortgage? What is that cost?
Is there an ability to continue to use the remaining credit available on the line after a conversion?
Is the conversion to a 30-year fixed term?
Is the payment on the converted line interest only or principle and interest?
How many times can I convert?
How often can I convert?
Some Typical Uses of Convertible HELOCs
Scenario 1
People use a convertible HELOC to complete a very specific project that may take time to accomplish. Consider a lengthy home improvement project. By taking a 2nd mortgage, you receive all the money from the financing immediately and begin paying interest on that amount from day one. This is not the most desirable outcome for a large-scale renovation or remodel. If you undertake a significant addition to your home you need time to go through the planning, permitting and specification phase of the project before building actually commences. This process often takes many months.
If you are planning on financing this upfront work with money from your home equity using a second mortgage would require you to pay interest on the full amount borrowed. With a HELOC you can draw little amounts at a time to pay for related expenses. Interest is only owed on the money borrowed.
In these types of situations a HELOC may save you money over the long run, as you are only charged interest on the money you borrow. However, once the project is complete and you anticipate no future withdrawals on your HELOC; converting to a fixed-rate allows you to keep your monthly payments fixed for the duration of the repayment period. This removes your exposure to jumps in the prime interest rate, and the concomitant increases in monthly payments.
Scenario 2
People also convert their HELOCs in to a fixed-rate loan once they’ve used the balance of their home equity line. Similar to the end state of scenario 1, once the HELOC is tapped out it makes sense to protect yourself from the exposure of rising interest rates. Converting the HELOC to a fixed-rate loan accomplishes that nicely.
Scenario 3
If interest rates begin to rise quickly and you have no current need for your equity line, converting to a fixed-rate loan can create dramatic monthly savings when compared to letting the interest rate float. This strategy makes sense usually under the following conditions:
You have multiple conversions available on your line.
You are able to continue to use the line after converting the currently-owed balance to a fixed-rate
If your line has these options, then converting the currently-owed balance to a fixed rate can provide you with stable monthly payments, while still maintaining access to your equity for future expenses.
Using the Convertible HELOC as a First Mortgage
Here is where convertible HELOCs get interesting; especially in a higher-rate environment like the one we are currently facing in the housing market. Let’s take the specific example of a home owner who maintains a property worth $1,000,000; a common scenario along the California coast. If they purchased the home within the last five years, or have refinanced in the last five years, they more-than-likely hold some type of jumbo, Alt-A 1st mortgage (or 1st and 2nd combo). Jumbo mortgages are anything over $417,000, the conforming limits for Fannie Mae and Freddie Mac purchase. Alt-A mortgages had low rates and loose qualifying guidelines during the past five years, making it easy for people owning expensive properties to find inexpensive financing. The mortgage market has changed dramatically in the last few months.
The current mortgage market for jumbo and Alt-A loans has been priced with a much higher premium to interest rate lately as the secondary mortgage market has balked at high-balance home loans. A jumbo loan in 2005 that was 6% is now 8% - a huge increase when considering the large loan amounts associated with high-end properties. On a million-dollar loan this change represents a 23% increase to the monthly payment. This has effectively locked high-end property owners out of the refinance or purchase markets.
It is especially painful to jumbo loan holders who are also in adjustable rate mortgages (ARMs) coming in to their adjustment period. Many Alt-A loans were mid-term ARMs with 3, 5 and 7 year terms. These loans face pricey payment adjustment schedules which can make a once affordable mortgage quickly unaffordable.
Here is where our friend the convertible HELOC comes in to play. Home owners facing the specter of an ARM reset in a jumbo loan can use the convertible HELOC in two ways to help reduce their mortgage payments. I call these the Two Gems of Convertible HELOCs.
Gem 1
Take the HELOC in first position as a 1st mortgage. Some convertible HELOCs convert to a much lower interest rate than their 1st mortgage jumbo competitors. Ask your mortgage professional what the going rate is on the converted loan and you may be surprised to find that it is nearly a full point lower than the going jumbo interest rate on the same loan. Continuing our $1,000,000 loan example from above; this 1% interest rate difference results in a 9% monthly payment savings. This savings can be the difference between affordable mortgage option and unaffordable mortgage option.
The reason this exists is that some HELOCs convert to the going 30-year fixed rate, regardless of other factors. Now this type of program is not available at every bank, if you can find a bank that does-you now have a viable jumbo loan alternative to the pricey 1st mortgage products available today.
This does carry some caveats. You must understand the conversion options, the rate that you’d be converting to, and any other limitations prior to signing on for the HELOC. Some banks make their conversions overly expensive to keep this type of financing from cannibalizing their jumbo loan financing pipeline. You also need to understand that you may have to carry the higher interest rate of the HELOC for a period of up to a week after signing loan documents. This requires that you have a very trusting relationship with the mortgage professional you work with; and that you verify all aspects of the HELOC documents carefully to ensure your conversion options match what you discussed during the loan process.
Gem 2
Instead of taking the whole loan balance as a 1st position HELOC, take a conforming 1st mortgage up to $417,000 and then take the remaining as a convertible HELOC. Once you sign the loan documents you can convert the HELOC to a fixed rate and achieve a blended interest rate (the effective interest rate of your 1st and 2nd mortgage combined) that can also be up to a point lower than the going jumbo loan rate.
In order to calculate the blended rate of the two mortgages use the following equations:
(1st Mortgage / Total Mortgage Amount) x 1st mortgage interest rate = Rate 1
(2nd Mortgage / Total Mortgage Amount) x 2nd mortgage interest rate = Rate 2
Rate 1 + Rate 2 = Blended Rate
An example:
1st Mortgage: $417,000
2nd Mortgage: $583,000
1st Mortgage rate: 6.5%
2nd Mortgage rate (after conversion): 8.5%
(417,000 / 1,000,000) x 6.5 = 2.71%
(583,000 / 1,000,000) x 8.5 = 4.96%
Blended rate: 7.67%
Conclusion
The convertible HELOC is an important financial tool for any homeowner; especially homeowners who are in jumbo loan products. As detailed in the example above a convertible HELOC can provide an avenue of lower-cost financing than the current Alt-A and jumbo loan markets currently offer. There are some definite caveats so it is important that you speak with a mortgage professional who can expertly match your current financing needs with the best combination of products available on the market today.
5 Ways to Use Your Home Equity Line of Credit
For most of us our home is our most valuable asset. When a large financial need arises, you can make this asset work for you by securing a home equity loan or line of credit. There are several benefits of a home equity line of credit. For example, this type of loan gives you access to a lump sum of cash for big ticket expenses like home renovations, the purchase of a car or college education. In many cases, the interest is tax deductible.
Sponsors (article continues below)
Home equity loans and lines of credit offer you the flexibility you need to meet a variety of financial needs. If you have an ongoing project or are not entirely sure how much your project will require, you might apply for a home equity line of credit. You can access loan funds via check or a special debit card as the need arises. If the project expenses are more fixed you may choose a home equity loan, which makes available a one time lump sum that can be used for any of a number of expenses. Following are some of the most popular uses for your home equity loan.
* Bill consolidation - credit card spending is on the rise. In fact, in recent years spending has outpaced saving and the average American carries nearly $10,000 in credit card debt. Using a home equity loan to bring your credit cards to a zero balance can save you thousands of dollars, especially when you consider how much interest you might accrue paying only the minimum on high balances each month. If you choose a home equity loan to pay off your credit cards be very careful to then use cash for most or all of your expenses. If not, you might find yourself with the burden of paying new credit card debts in addition to loan payments. Don't forget a home equity loan is secured by your home. If you fail to repay the loan as agreed you run the risk of foreclosure.
* Education - Most parents want to help their children meet educational expenses, but let's face it, with so many other expenses it can be tough. A home equity loan or line of credit gives you access to the money you need to help your with tuition and other educational expenses.
* Renovation or remodeling projects - Your home is probably your greatest investment. A home equity loan or line of credit can help you protect and build on your home's value by completing renovations. Your loan can also make it possible to add that second bathroom or home theatre you have been dreaming of, or even that gourmet kitchen.
* Travel - The vacation of a lifetime awaits. Perhaps you have always dreamed of traveling to Africa or China. Your home can be your ticket. Home equity loans can be used for just about anything you can imagine and the trip you have always dreamed of may be the perfect way to celebrate a 50th birthday or silver anniversary.
* Buy a new car - Using a home equity loan can actually save you money when buying a car. A home equity loan can make it possible for you to approach the dealer with the full amount of the sticker price in hand giving you more power to negotiate and retain incentives. You may also save significantly off of dealer financing interest rates.
Home equity lines of credit make it financially possible to do more of the things that are important to you. These loans can be an important part of building a strong financial foundation for you and your family. But you must proceed with caution. Home equity loans are secured by your home. If you fail to honor the terms of the loan agreement, the lender may exercise the legal option of repossessing your property to cure the default. You could lose your home in as little as 5 weeks in some states. It is important to have a repayment plan you are comfortable with and to understand the laws in your state before you agree to the loan terms. A home equity loan should help you improve your financial picture, not risk homelessness.
Sponsors (article continues below)
Home equity loans and lines of credit offer you the flexibility you need to meet a variety of financial needs. If you have an ongoing project or are not entirely sure how much your project will require, you might apply for a home equity line of credit. You can access loan funds via check or a special debit card as the need arises. If the project expenses are more fixed you may choose a home equity loan, which makes available a one time lump sum that can be used for any of a number of expenses. Following are some of the most popular uses for your home equity loan.
* Bill consolidation - credit card spending is on the rise. In fact, in recent years spending has outpaced saving and the average American carries nearly $10,000 in credit card debt. Using a home equity loan to bring your credit cards to a zero balance can save you thousands of dollars, especially when you consider how much interest you might accrue paying only the minimum on high balances each month. If you choose a home equity loan to pay off your credit cards be very careful to then use cash for most or all of your expenses. If not, you might find yourself with the burden of paying new credit card debts in addition to loan payments. Don't forget a home equity loan is secured by your home. If you fail to repay the loan as agreed you run the risk of foreclosure.
* Education - Most parents want to help their children meet educational expenses, but let's face it, with so many other expenses it can be tough. A home equity loan or line of credit gives you access to the money you need to help your with tuition and other educational expenses.
* Renovation or remodeling projects - Your home is probably your greatest investment. A home equity loan or line of credit can help you protect and build on your home's value by completing renovations. Your loan can also make it possible to add that second bathroom or home theatre you have been dreaming of, or even that gourmet kitchen.
* Travel - The vacation of a lifetime awaits. Perhaps you have always dreamed of traveling to Africa or China. Your home can be your ticket. Home equity loans can be used for just about anything you can imagine and the trip you have always dreamed of may be the perfect way to celebrate a 50th birthday or silver anniversary.
* Buy a new car - Using a home equity loan can actually save you money when buying a car. A home equity loan can make it possible for you to approach the dealer with the full amount of the sticker price in hand giving you more power to negotiate and retain incentives. You may also save significantly off of dealer financing interest rates.
Home equity lines of credit make it financially possible to do more of the things that are important to you. These loans can be an important part of building a strong financial foundation for you and your family. But you must proceed with caution. Home equity loans are secured by your home. If you fail to honor the terms of the loan agreement, the lender may exercise the legal option of repossessing your property to cure the default. You could lose your home in as little as 5 weeks in some states. It is important to have a repayment plan you are comfortable with and to understand the laws in your state before you agree to the loan terms. A home equity loan should help you improve your financial picture, not risk homelessness.
What Is A Home Equity Line of Credit?
What Is A Home Equity Line of Credit?
[May 16, 2008.]
Home owners have several options open to them when they find themselves in need of cash. Since the home is one of the greatest assets anyone will ever have these options often involve using the home as collateral for the loan. These loans come in different forms and are called by different names depending on the area and location.
One of these loans is the Home Equity Line of Credit which is quickly replacing mortgages as a way of securing a loan. The reason for this shift is that Home Equity Line of Credit looks a bit better on Credit Reports then mortgages. Home Equity Lines of Credit work much in the same way as home mortgages or deeds of trust. In both cases the home owner takes a loan out from a bank or other institution which places a lien on the property. The only real difference is that the home owner does not get the total sum of the loan upfront. Instead, the home owner will be able to take out increments of the total loan amount during the term of the loan. Many compare this with a credit card expect that the home has a lien placed upon it and if you are unable to pay the loan back then the property will undergo foreclosure.
To determine your credit limit for the Home Equity Line of Credit the lender will look at your financial history including your credit report and rating. They will also review your income, assets, and whatever debt you may already have. When approved, you and the lender will get together to draw up a plan which will include what the credit limit will be and how long the draw period will be. The interest rate on the Home Equity Line of Credit is often based on the Annual Percentage Rate and is usually not fixed so it is pretty much guaranteed to go up on occasion. There will be limitations and restrictions placed on the line of credit such as when and how much you can draw on it so be sure to understand the terms and conditions fully.
Reasons for taking a Home Equity Line of Credit are similar to the reasons why people take out mortgages. The most popular reason is emergencies such as sudden illnesses or home repairs as a result from floods or other natural disasters. Other reasons include car repairs, educational purposes, weddings, and even vacations.
Repayment of the Home Equity Line of Credit can take place during the life of the loan or in one lump sum at the end of the period. During the life of the loan it is possible that you will only be required to pay the interest every month. While this may have short term benefits you must remember that at the end you are responsible for paying off the entire loan. Take this into consideration as you think about whether or not you should use a line of credit to pay for expenses. You will also need to be aware that the interest rates are variable and will change during the life of the loan this will mean an increase in the monthly payments. If you are unable to pay the loan off you will loose your home.
Home Equity Line of Credit is a great option for anyone that may not need a huge sum of money upfront or that would rather not have the stigma of a mortgage on their credit report. Whatever the case you will need to keep up with the monthly payments just like with any other loan or you run the risk of loosing your home.
[May 16, 2008.]
Home owners have several options open to them when they find themselves in need of cash. Since the home is one of the greatest assets anyone will ever have these options often involve using the home as collateral for the loan. These loans come in different forms and are called by different names depending on the area and location.
One of these loans is the Home Equity Line of Credit which is quickly replacing mortgages as a way of securing a loan. The reason for this shift is that Home Equity Line of Credit looks a bit better on Credit Reports then mortgages. Home Equity Lines of Credit work much in the same way as home mortgages or deeds of trust. In both cases the home owner takes a loan out from a bank or other institution which places a lien on the property. The only real difference is that the home owner does not get the total sum of the loan upfront. Instead, the home owner will be able to take out increments of the total loan amount during the term of the loan. Many compare this with a credit card expect that the home has a lien placed upon it and if you are unable to pay the loan back then the property will undergo foreclosure.
To determine your credit limit for the Home Equity Line of Credit the lender will look at your financial history including your credit report and rating. They will also review your income, assets, and whatever debt you may already have. When approved, you and the lender will get together to draw up a plan which will include what the credit limit will be and how long the draw period will be. The interest rate on the Home Equity Line of Credit is often based on the Annual Percentage Rate and is usually not fixed so it is pretty much guaranteed to go up on occasion. There will be limitations and restrictions placed on the line of credit such as when and how much you can draw on it so be sure to understand the terms and conditions fully.
Reasons for taking a Home Equity Line of Credit are similar to the reasons why people take out mortgages. The most popular reason is emergencies such as sudden illnesses or home repairs as a result from floods or other natural disasters. Other reasons include car repairs, educational purposes, weddings, and even vacations.
Repayment of the Home Equity Line of Credit can take place during the life of the loan or in one lump sum at the end of the period. During the life of the loan it is possible that you will only be required to pay the interest every month. While this may have short term benefits you must remember that at the end you are responsible for paying off the entire loan. Take this into consideration as you think about whether or not you should use a line of credit to pay for expenses. You will also need to be aware that the interest rates are variable and will change during the life of the loan this will mean an increase in the monthly payments. If you are unable to pay the loan off you will loose your home.
Home Equity Line of Credit is a great option for anyone that may not need a huge sum of money upfront or that would rather not have the stigma of a mortgage on their credit report. Whatever the case you will need to keep up with the monthly payments just like with any other loan or you run the risk of loosing your home.
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