Why do homeowners take out a Heloc (line of credit) or a fixed second? Many home owners after a while accumulate high interest credit cards, personal loans, auto loans, solar panels and home repairs or a need for cash for an investment. This is where an equity loan may make sense. You may be able to convert your non-deductible high interest revolving credit into one easy tax-deductible loan and keep the unused line of credit for any future emergencies or investment opportunities. A HELOC often has a lower interest rate than some other common types of loans, and the interest may be tax deductible. Recently tax-deductible mortgage interest may have changed. Please consult your tax advisor regarding interest deductibility as tax rules may have changed.
How a HELOC works
As time goes by equity builds up and you have available equity in your home, meaning that the amount you owe on your home has gone down and now your home has become more valuable. Your home will used as collateral. You will need a current appraisal. Than a calculation will measure the total loans divided by the appraised value.
As you repay your outstanding balance, the amount of available credit is replaced much like a credit card up to your limit. The big difference is you may have a smaller payment, you can choose to pay interest only or pay any amount above the minimum interest payment. This means you can borrow against it again and you can borrow as little or as much as you need throughout your draw period typically 10 years up to the credit limit. At the end of the draw period, the repayment period (typically 20 years) begins.
What is the qualification for a Heloc?
You can typically borrow up to 90% to 95% of the value of your home minus the amount you owe. This is called the cumulative loan to value (CLTV). What the lender will look at is how have you managed your credit in the past. If you have a low Fico score or a high Fico that will be reflected on the rate and terms of your Heloc. What is your employment history, monthly income and monthly debts?
Variable interest rate vs Fixed
With a Heloc you either have a variable interest rate on your home equity line of credit, the rate can change from month to month or the other type is a variable rate will change at the end of the year with a 2% cap. This means that the annual rate cannot change more than 2% up or down. The life time maximum is usually 18%. The variable rate is calculated from both an index and a margin.
How does a bank charge for a Heloc? Banks use and index as a financial indicator to set rates on many consumer loan products. The U.S. Prime Rate as published in The Wall Street Journal is a popular index for HELOCs. The index and the margin make up the total interest you will pay for a Heloc. The margin is what the bank charges for the Heloc. The margin remains constant for the life of the line of credit.
Fixed Rate Interest Option:
Payments are usually Principal and Interest (P&I) you make on a Fixed rate loan are paid until your period you choose. You can choose 5,7,10,15 and 20 year fixed. The shorter the term the higher the payment. One advantage with Heloc’s is the rates tend to be lower and you have the option to pay interest only.
