Exactly what is a home equity line of credit or HELOC? A home equity
line of credit, which lenders and mortgage brokers refer to as a HELOC,
is a different kind of home loan. An equity line has different rates and
terms from a conventional first mortgage. In a standard home loan, or
mortgage, your monthly payments cover both the principal loan and the
interest you are charged.
Most mortgage payments include escrow, or taxes and insurance. An equity
line of credit payment does not reduce your principal loan amount and
does not include escrow. You are borrowing the equity in your house and
paying the bank an interest premium on that loan. With a HELOC, you pay
only the interest on the loan and, generally, you get the money for less
time than you do a standard first mortgage.
The underwriting on these loans is very simple, and in most cases, the
loans are very easy to get. At close, you either get one big check,
which you can deposit into your savings or checking account or you can
get a check book and treat your equity line of credit as another
checking account. The payment on equity lines is very enticing. Paying
interest only makes for a very low payment. It’s important to remember,
though, when paying interest only, you are not paying down the principal
loan balance.
The Power of Interest-Only Payments: So, let’s suppose you take an
equity line for $50,000 at 4.25% interest. This interest rate is based
on the Prime rate, a floating rate that can change but does not
fluctuate very often. When this article was first published, the prime
rate was 4.25 percent. So, on your $50,000 equity line of credit, your
payment is $177.00 each month. This is an incredibly low payment on a
loan of this size. This gives you a great deal of power, because you can
control a large sum of money for an extremely low monthly payment. It is
this low, because you are only paying the interest on the loan.
At the end of the first year, you will have paid the bank over $2,100.
You will, however, still owe $50,000. This is because your monthly
payment is an interest-only payment. This is where some people can get
in trouble with home equity lines of credit. If you use all the equity
in your home and never pay down the balance, then decide to sell your
house, you won’t make anything on the sale, because you’ll owe it all to
the bank.
It is also important to understand the terms on a home equity line of
credit (HELOC). When talking to mortgage professionals about home equity
lines of credit, be sure you understand the terms, as lenders vary on
what they’ll offer. Like conventional mortgages, which have terms of 30
years, 15 years, 10 years, etc., home equity lines also have various
terms, but not all lenders offer them. Don’t let this confuse you. Just
find your trustworthy mortgage broker, and tell him or her exactly what
you want.
Unlike mortgage payments, which include complicated yearly amortization
of the principal loan amount, interest-only payments are calculated very
easily. You can do it in two simple steps. To find out your payment,
first learn what rate of interest you’ll be charged. If you are using 80
percent or less of the equity available and you have an A credit rating,
you’ll be able to get the best rate available, which is the prime rate.
Now, let’s assume you have $40,000 in equity in your house, but you only
need $20,000 (taking less than 100% of the equity is important). You
take $20,000 and multiply it by 4.25%, which gives you 850. This is what
you’ll pay each year to borrow $20,000. Next, divide the 850 by 12 for a
monthly, interest-only payment. Your payment for your $20,000 home
equity line of credit is $70.83.
This is a very powerful loan. Imagine paying less than 71 dollars for
the ability to control $20,000. Some people pay more for cable TV or
their monthly cell phone bill. Some people even take the equity in their
home and invest it elsewhere. You’re probably figuring out how much
equity you have right now, and what you can do with that money!
To learn how you can turn your equity into a never-ending money cycle
that will fill your bank account year after year, read Winning the
Mortgage Game. Whatever you decide, open the cash vault inside your
home, and make use of your equity today.
