Shopping for a home equity line of credit (HELOC) is a relatively simple process compared to shopping for a mortgage mainly because with a HELOC the most important features you need to look for are the same from one lender to another. Still, it has some specific characteristics you need to be familiar with in order to shop successfully.
Here are some of the most important features of home equity lines of credit you should understand and examine when shopping for a HELOC.
Before you decide to apply for a home equity line of credit you should be well aware of the risks involved and particularly the higher exposure to interest rate risk. HELOC is an adjustable rate line of credit, rather than a loan for a specified amount, and its interest rate adjusts every time there is a change in the prime rate, on the first day of the month following the change. This characteristic makes HELOCs riskier in case of interest rate increasing than the standard ARMs which have longer periods for adjustment.
Interest rate charges and margins:
Generally, all HELOCs are tied to the prime rate, as stated in the Wall Street Journal. This considerably facilitates their shopping in contrast to adjustable rate mortgages, for example, which can be tied to different indexes and require more researching.
However, HELOCs typically charge variable rather than fixed interest rates. In order to obtain the interest rate the borrower will be charged, a certain amount, known as margin, is added to the prime rate. Borrowers and shoppers should always find out what the margin is because it varies among different lenders.
Lenders of home equity lines would typically offer a temporarily discounted, low interest rate lasting for a relatively short introductory period (for example 6 months). After the introductory period ends the rate is based on the prime rate plus the margin.
Minimum draw limits:
One of the things the borrower needs to look for when applying for a home equity line of credit is whether there are a minimum draw limits, or a minimum average loan balance. Some plans have limitations on how you use the HELOC and may require a minimum draw amount each time you borrow money and the keeping of a minimum amount outstanding.
Costs and fees:
Many of the up-front costs and fees of setting up a home equity line of credit are of the same type as on regular mortgages. Such charges include a property appraisal fee, an application fee, and points (though lenders seldom charge points). In addition to those, shoppers would have to pay an annual fee (which is often waived the first year) and a cancellation fee (which is often waived after 3 years).
If you are shopping for a home equity line of credit you should examine and evaluate each of the above features to ensure that the terms of the plan you choose corresponds to your borrowing needs. Always have in mind that failure to repay the lines of credit may cost you the loss of your home.