Home Equity Line of Credit - HELOC

A Home Equity Line of Credit, or HELOC, is a line of credit extended to a borrower using their house as collateral, meaning that the bank may foreclose your home if you do not make payments on this loan.  It can be viewed as a second mortgage and the lender will appraise your home and provide you with a credit line up to a maximum of the difference between the appraisal value and the aggregate outstanding liens against the house.  Some lenders will finance up to 125% of the value of your home but that has been almost eliminated due to the credit crisis of 2008

The available credit on the HELOC will be available to be "drawn" at any time during the draw period.


Draw Period


A draw period is the time in which the lender will allow you to use the credit line as an ATM with interest charges.  Once the draw period is over, the line of credit will convert to a fixed rate fully amortizing loan or a balloon payment (which stipulates that the entire outstanding balance is due) unless you refinance the line of credit with another lender. 

Interest Charges


Interest will be charged each day on the oustanding balance of that HELOC and interest rates will be agreed upon during the loan origination process.  Typically, interest rates are tied to the prime lending rate set by the federal reserve.  The rate will be a floating rate that is tied to prime.  Lenders will usually set a rate equal to prime + or - a margin.  For borrowers with very high credit quality, margin could actually be negative as the risks associated to the line of credit are far less than a subprime borrower, who would be charged a higher margin.  HELOCs are interest only products during the draw period.  Borrowers who take out credit lines which do not take out the 80% loan to value (LTV) threshold will receive better rates as their leverage is not as high. 

Other Considerations


HELOCs grew in popularity due to their ability to structure first mortgages up to a loan value equaling that of 80% of the appraisal.  Borrowers with little or no down payment would then utilize a HELOC to finance the remaining balance after the first mortgage of 80%.  The purpose of structuring the loan in this fashion as opposed to financing it for the entire amount is to avoid PMI, or private mortgage insurance on loans greater than 80% LTV.  This would save the borrower quite a bit of money each month; however, it will expose them to the interest rate risk of the HELOC being tied to the prime lending rate. 
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