Designing a Mortgage That's Right For You!
A home equity line of credit (HELOC) allows you to use your home equity as collateral to secure a revolving credit line for major purchases, such as:
. Home renovations
. College or university tuition fees
. A wedding
. Medical bills and much more
When you apply for a HELOC, you'll be approved for a specific credit limit. The amount of credit you're approved for is based on a percentage of the home's appraised value minus the balance owed on the existing mortgage.
For example, suppose the appraised value of your home is $100,000 and you have $40,000 owing on the mortgage. The lender has set your credit limit to 80 percent of the appraised value of your home. Subtract the mortgage balance from 80 percent of the appraised home value ($80,000, in this case), and you'll get your potential line of credit: $40,000. To determine your actual credit limit, the lender will consider your ability to repay the loan principal and interest based on your income, debts, credit history, and other financial obligations.
Many HELOCs are fixed to a set period during which you can borrow money, such as 10 years. This period is called the 'draw period'. During the draw period, you are permitted to renew your credit line. If your plan doesn't allow renewals, you won't be able to borrow again until the draw period has ended. Some HELOCs require full payment of any outstanding balance at the end of the period. Others allow you to repay over a fixed period or 'repayment period' - usually 15 to 20 years.
Once you are approved for a HELOC, you can borrow up to your credit limit anytime you want. You'll be given special checks to draw n your credit line. Depending on your plan, you may be able to use a credit card or draw on the line.
HELOCs aren't without certain limitations. Some plans require you borrow a minimum amount each time you draw on the credit line (for example, $250). Other plans require that you keep a minimum balance outstanding. You may also be required to take an initial advance when the HELOC is set up.
Variable Interest Rates
HELOCs generally involve variable as opposed to fixed interest rates. The interest rate you pay for the line of credit will fluctuate according to changes in value on a publicly available index, such as those published in major daily newspapers. Your interest rate will be based on the value of the index at a particular time, plus a 'margin' - say, 2 percentage points. Depending on your plan, you may be able to convert a variable-interest rate to a fixed rate over the duration of the period.
When your HELOC ends, you may be required to pay the entire balance - called a 'balloon payment' - all at one. If you aren't prepared to make the balloon payment, you could lose your home. The full balance of your HELOC also becomes due if you sell your house. If you're planning to sell your home in the near future, keep in mind the up-front costs associated with setting up a credit line.