How Is the Principal Payment Calculated on a Home Equity?
You have the potential to borrow against the equity in your home. When a bank extends you this opportunity in the form of semi-revolving credit as opposed to a lump sum with a defined repayment schedule, it is called a home equity line of credit or HELOC.
Other People Are Reading
-
Understanding HELOC
-
A bank will approve you for a HELOC based on percentage of your home appraised value (75 percent is common) and subtracting that value from your equity stake in the home.
For example if the appraised value of your home was $225,000 and you had an outstanding mortgage balance of $150,000 then you would qualify for a HELOC of $18,750.
($225,000 x .075)-$150,000=$18,750.
Repayment Options.
-
You can repay your HELOC in a variety of ways depending on what your bank offers. Some banks require that only pay interest for a specified time frame and then pay the principal balance in full at the end of the time frame. In this scenario if you took out a HELOC of $18,750, used the money to pay off your car, and agreed to a sixty month interest only repayment schedule your monthly payment would be $140.63 a month based on a nine percent interest rate.
The other repayment option is a percentage of the outstanding principal balance over a set time with a lump sum payment due at the end of the period. Paying 2 percent of your principal balance on $18,750 borrowed for a period of 60 months would cost you $5960.90 in interest charges and would leave you with a lump sum principal balance of $8,815.11.
-
HELOC Interest Calculated Daily
-
The calculation works this way: Interest rate divided by days in the year. Multiply this number by average daily balance in the month to determine interest accumulations.
.09/365=.00025. .00025x18750=4.69. A 30-day month would accrue $140.70 in interest and a 31-one day month would accrue $145.39 in interest.
Your payment changes every month because as your principal is reduced your daily interest rate is multiplied by a smaller number.
HELOC Advantages
-
When you establish a HELOC you are generally giving a time frame from which you can use the money. Banks call this a draw period. During the draw period you can use the HELOC to secure funding for major purchases, such as college tuition for a child or you can use the money for debt consolidation. Interest begins to accumulate on any money used on the day it is drawn.
HELOC Risks
-
HELOCs carry a great deal of risk. For one, the interest rate on a HELOC is not fixed and can be adjusted at any time. If you had a 9 percent interest rate and were making principal payments of 2 percent on a 60-month repayment schedule at the end of month 29, you would have a principal balance of $13,018.98. Now your bank decided to double your interest rate to 18 percent. (.18/365=.0005) ($13,018.98x.0005=$6.51)
From month 30 through month 60 you would pay $5,452.96 in interest and would have a principal balance of $11,201.34.
If you default on your HELOC your bank can file a lawsuit to put a lien on your house or if the amount owed is substantial enough, it will file a lawsuit to force the sale of your house. This is essentially a foreclosure.
-
References
- Photo Credit house image by Brett Bouwer from Fotolia.com
