Are Minimum Payments Required on a Home Equity Line of Credit?
People who take out home equity lines of credit normally receive a monthly bill requesting a minimum payment. Banks and credit unions bill HELOCs in a similar manner to the way financial institutions bill people for credit cards. Borrowers can pay either the minimum due or an amount in excess of that.
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Significance
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Most banks require borrowers with balances on their HELOCs to make a minimum payment equal to the greater of $75 or the amount of the accrued interest. When approving borrowers for home equity lines of credit, banks calculate the borrower's debt-to-income ratio by assuming a regular monthly payment equal to 1.2 percent of the line amount. Lenders also use this calculation when approving people with HELOCs for other products such as car loans. Lenders use this method because it recognizes the fact that a borrower could choose to max out their HELOC at any time.
Features
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The Federal Open Market Committee sets the overnight borrowing rate, known as the federal funds rate, that banks pay when they borrow from each other or from the Federal Reserve. Each bank normally sets its prime rate at 3 percent above the federal funds rate. The Wall Street Journal surveys the largest banks in the nation and bases its prime rate upon the rates charged by the majority of the banks. Most HELOCs are priced using the Wall Street Journal's U.S. prime index rate.
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Types
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Many home equity line of credit agreements enable borrowers to lock a portion of their balance to a specified rate for a certain period of time. Many HELOC contracts allow borrowers to have four or five separate rate locks at a time. People who choose rates lock options receive statements requiring them to make payments towards each of their rate lock options as well as the minimum monthly payment. People who lock in their entire balance do not also have to make a minimum interest-only payment.
Misconceptions
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Many people do not realize that HELOCs are mortgages. People who fail to make payments risk losing their homes. Some banks do not offer HELOCs as first lien mortgages because some customers might request banks to offer escrow services for the loans. Many banks allow borrowers to take out HELOCs in first or second lien position. People can take out HELOCs as purchase or refinance loans on primary residences, second homes or rentals.
Warning
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The FOMC raises the federal funds rate when the U.S. enters inflationary cycles. The board does this to discourage lending but it impacts borrowers with existing loans such as HELOCs that use the prime rate as a pricing index. During the 20th century, prime rose as high as 20 percent and fell below 2 percent. Due to potential rate hikes, people who take out HELOCs expose themselves to the risk of their monthly minimum payment doubling or tripling within a short space of time.
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