What Is A Heloc

HELOC stands for home equity line of credit. It is a loan set up as a line of credit for some maximum draw, rather than a fixed-dollar amount. Using a standard mortgage you might borrow $150,000, which would be paid out in its entirety at closing. Using a HELOC instead, you receive the lender’s promise to advance you up to $150,000, in an amount at the time of your choosing. You can draw on the line by writing a check, or with a special credit card, or in some other ways.

HELOCs are usually second mortgages, but more and more are being used as a first mortgage. You would be using your HELOC as a first mortgage if you refinanced your existing first mortgage. Using a HELOC as a substitute for a first mortgage can be risky. Because the balance of a HELOC can change from day to day, but that depends on the draws and repayments. Interest on a HELOC is calculated daily rather than monthly. Interest would calculated differently with a standard loan, and would not be as costly as the interest on a HELOC would be as a first mortgage.

HELOCs have a draw period. This is when the borrower can use the line of credit and a repayment period for the repayment of the line of credit. Draw periods are usually 5 to 10 years while the repayment period is usually 10 to 20 years. There are some HELOCs that require payment of the entire balance at the time of the draw period. Sometimes the borrower has to refinance to repay the line of credit.

HELOCs are convenient for funding intermittent needs, such as paying off credit cards, making home improvements, or paying college tuition. You draw and pay interest on only the money you need. The cash paid up front are relatively low. When borrowing $150,000 with a standard loan, settlement costs may range from $2-5,000, unless the borrower pays a high enough interest rate for the lender to reduce some of the costs or pay all of it. With HELOC on a $150,000 costs seldom go over $1,000 and in many cases are paid by the lender with a rate adjustment. Some HELOCs are convertible into fixed-rate loans at the time of a draw. This is a good option for borrowers who draw a large amount at one time.

The disadvantage of the HELOC is the interest rate is subject to rise. All HELOC’s are adjustable rate mortgages, but they are much riskier than standard adjustment rate mortgage. Changes in the market effect the HELOC very quickly. Most adjustable rate mortgages have rate adjustment caps, which sets a limit on the size of the rate changes. The HELOC doesn’t have adjustment caps and the maximum rate is as high as 18 percent.

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