Home Equity Line of Credit

HELOC WITH MORTGAGE MARK

 

A Home Equity Line of Credit (HELOC) is a Second Lien Mortgage that allows a borrower to access their equity and pull money out of their home. Unlike most home equity loan options, a HELOC has a variable rate AND has a variable loan amount. This line of credit allows a homeowner to take out cash and draw against the line for a certain period of the loan’s life which changes the balance and the payments owed. (Think of it like a credit card – the balance can be charged up and then paid off at any time).

Features of HELOC

Like the majority of other articles on this blog we are writing this article for HELOC loans in Texas; other states have more liberal LTV guidelines. Like all home equity loans in Texas, a HELOC is considered an “Texas Home Equity A6 Refinance ” loan which means the loan cannot be refinanced for 12 months and can’t be originated any sooner than 12 business days. Moreover, there are no prepayment penalties for paying off or closing the HELOC early. The interest paid on a HELOC is Tax Deductible Interest for an amount up to $100,000.

Reason To Get A HELOC

A HELOC is an awesome option for many homeowners that need shorter-term money (i.e. need some cash for a few short years). Because a HELOC is a variable interest rate loan the long-term viability is questionable because we don’t know where rates will be in the future and higher rates mean higher payments. Note: there are fixed-rate home equity loans available that may be more viable for a longer term solution.

Another reason why someone may want a HELOC is to have a “safety net” of accessible funds. Because payments are based off the amount owed someone can open a line, leave the balance at zero, and not have any payments. They then have the peace of mind knowing that they have funds accessible to them should they need them.

ERMS AND CONDITIONS OF HELOC
HELOC Terms

In most cases a HELOC is a 20 year note where the first 10 years have the “line of credit” feature. This means you have 20 years until the loan will need to be paid off in full; however, for the first 10 years you can draw against the line and change the balance owed. After the initial 10 year draw period expires, the Line Of Credit option will “close” and the balance owed at that time will be what’s due to the bank. The remaining 10 years will be fully amortized payments so that at the end of the loan’s life the balance will be paid down to zero.

Interest Rate

A HELOC has a variable rate that is tied to the Prime Rate which means the rate will change whenever the Fed moves interest rates. Prime is ultimately determined by the Federal Reserve and is typically 3% above the Fed Funds Rate. So when you read that the Fed raised rates to 0.5% you can know that the Prime Rate will be 3.5%.

The interest rate for a HELOC is typically Prime + “X”. This “X” can range from .5% to 1.5% depending on the borrower’s credit. Let’s assume for our examples that the HELOC rate will be Prime + 1% where Prime is 3.5%. This makes the HELOC’s rate 4.5%.

Payments

Payments during the draw period (i.e. the first 10 years) are interest only payments and are based only on the amount borrowed. After that the last 10 years’ payments are fully amortizing principal and interest payments that are based on the loans’ balance at the end of year 10.

Example Scenario

Let’s assume “Joe Homeowner” gets a $100k HELOC. After Joe opens the HELOC he doesn’t pull anything from the line and leaves the balance at zero. Because the payments are based on the balance (zero in this case), Joe won’t have a payment due for those six months.

Draws Change Balance

Now let’s assume three more months go by and Joe pulls out $50,000 when the interest rate is still at 4.5%. The payments for the following months will now be $187.50 until the balance or rate changes. ($50k x .045 = $187.50 per month).

Interest Rate Change

Now let’s say that $50k balance remains constant for five more month and then the Fed increases rates by .5%. This makes the HELOC’s rate 5% in our example (was 4.5% + .5% rate increase =5% for new rate). Joe’s payments are now $50k x .05 = $208.33 per month.

10 Years Later

Let’s just assume that Joe keeps the $50k balance for the remaining time (even though he can pay it down, pay it off, or draw more from it for those first 10 years). At the end of those 10 years the line of credit feature is closed, and this means the $50k becomes the basis for payments over the remaining 10 years. Let’s assume the interest rate is at 7% when that happens; the payments then become $580.54 since it will be a fully amortizing loan for the remaining 10 years for $50k at 7%. At the end of the 20 years the balance will then be zero and the HELOC is paid in full and done.

LTV Limitations

Like all home equity loans in Texas, the maximum Combined Loan to Value (LTV) is limited to 80%. In addition to the 80% CLTV, the maximum Loan to Value (LTV) is limited to 50%.

CLTV Example

Let’s assume someone has a house worth $400,000 and they currently owe $300,000 on the home. If they want to get a HELOC to get some cash out they will be limited to $20,000 because of the $320,000 maximum CLTV. ($400k x 80% =$320,00 max CLTV and then $320k max – $300k current loan = $20k available for the HELOC).

LTV Example

Let’s now assume that the same homeowner with the $400k home has a $100k first lien and wants a HELOC. The maximum amount of the HELOC will now be limited to $200k because the HELOC can’t exceed 50% LTV. ($400k x 50% = $200k max HELOC loan amount). Even though 80% of the $400k is $320k and the $100k first means there should be $220k available for the HELOC, the 50% limitation applies so only $200k of that $220k is accessible for a HELOC. Note: a fixed rate second lien equity loan is available as well as a “normal” cash out home loan where your refinance the first lien and take cash out. Call us if you have questions and we can walk you through it.

HELOC Fees

The fees for a HELOC a relatively inexpensive. Most banks’ fees will range from $0 (free) to $500. The “wild card” card is whether or not they will require an appraisal. If an appraisal is required then it adds about $400 to $500 in costs. Often times the appraisal requirement can be waived if the County Appraisal District’s (CAD) assessment value is used in lieu of an appraisal. Check out Dallas, Collin, Tarrant, Denton, and Rockwall county’s website and look up your address if you want to determine the county’s assessed value.