Advice on a Home Equity Line of Credit
A home equity line of credit is an alternative to other types of loans. Since a house secures this type of loan, the lender can charge a lower interest rate on the loan than it charges on unsecured debts, such as credit cards. The disadvantage of a home equity line of credit, or HELOC, is that if the borrower cannot make payments on this line of credit, the lender can repossess the home.
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House Value
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The amount of money available from the home equity line of credit depends on the value of the house. The lender usually offers a percentage of the total equity value of the house, such as 80 percent. The homeowner can take out a larger loan if a larger portion of the mortgage is already paid off. The homeowner may wish to have an appraiser calculate the value of the house if the house has not been appraised recently, since the house may be worth more than it was at the last appraisal.
Repayment Date
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A home equity line of credit may include a due date when the home owner must pay off the loan. The lender may allow the home owner to renew the credit line. If the lender does not allow renewal, the home owner may have the option to repay the current balance over a period of several years, or may have the obligation to pay off the full balance of the loan when it becomes due. If the full balance of the loan is large, the lender may foreclose on the house if the homeowner cannot repay the debt.
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Credit Line Reduction
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Since the equity in the house guarantees the home equity credit line, the lender can reduce the credit available if the value of the house decreases. The home equity borrower may have less money available in the line of credit than the current loan balance, so the lender may freeze the account. If the borrower has outstanding checks, these checks will bounce when the line of credit is frozen, leading to additional charges in addition to the loan payments.
Prepayment Penalties
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A lender may have the right to charge prepayment penalties on a HELOC. Prepayment penalties apply when the borrower pays off a debt early, and can be worth paying in some cases since the borrower avoids making additional interest payments. If the borrower repays a HELOC early, the lender may be able to charge the borrower for certain expenses, which include appraisal costs and fees to check the title of the property.
Variable Rates
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Home equity lines of credit often include variable interest rates. A variable interest rate includes risk because if interest rates increase, the amount of the monthly payment that the home owner must pay also increases. Government regulations limit the maximum increase in the interest rate for a home equity line of credit, according to the Federal Reserve Bpard website about home equity lines of credit. The home owner may select a fixed rate home equity line of credit to avoid this potential rate increase.
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References
- The Federal Reserve Board: What You Should Know About Home Equity Lines of Credit
- U.S. Department of the Treasury: Answers About Home Equity Lines of Credit and Home Equity Loans
- State of Washington: The Ability of State-Chartered Credit Unions to Charge Prepayment Penalties or Recoupment of Costs on HELOC Loans
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