Home Equity Loans and Lines of Credit
September 6, 2017
Ruth Jenkins President & CEO
Q: Fall is in the air, and with it comes the promise of cooler weather. Now is the time many people will consider undertaking home improvement projects. How can those looking to do home improvements finance their projects?
A: It is common for people to use the equity in their home to finance major home improvement projects.
Q: Is there more than one way a consumer can use their home equity for lending purposes?
A: Yes, there are two types of home equity lending, loans and lines of credit:
- Home equity loans are installment loans, like regular mortgages and auto loans.
a. You’re given a certain amount of money which you typically receive all at once and pay back according to a set schedule, over time.
b. Home-equity loans usually come with fixed rates and fixed payments.
- Home equity lines of credit, by contrast, work more like credit cards.
a. You’re given a credit limit that you can borrow against, and paying down your debt frees up more credit that you can potentially spend.
b. Home equity lines of credit have variable interest rates that are typically tied to the prime rate.
Q: Can you use home equity to finance more than just home improvements?
A: Yes, don’t let the name deceive you.
- Just because you are borrowing against the market value of your home does not mean you are required to use the loan or line of credit only for home-related items.
a. Because a home often is a consumer’s most valuable asset, many homeowners use home equity credit lines only for major items
i. education, home improvements, or medical bills
Q: How can an individual determine which is better for them—a home equity loan or home equity line of credit?
- A home equity loan is generally the best choice when you know exactly how much your purchase is likely to cost and you need several years to pay it off.
a. A major home-improvement project, for example, might be a good candidate for a home equity loan.You also might consider a loan, rather than a line of credit, when you want to lock in a low interest rate in a rising-rate environment.
- A line of credit may be a better option for shorter-term borrowing, or when you want to be able to tap your home equity to cover emergencies.
- Regardless of which you choose, it is very important to keep in mind that with either type of borrowing, you’re pledging your home as collateral and that it is very important not to fall behind on your payments.
Q: How is the credit limit for a home equity line of credit typically determined?
- With a home equity line, you will be approved for a specific amount of credit.
a.Many lenders set the credit limit on a home equity line by taking a percentage (say, 80%) of the home’s appraised value and subtracting from that the balance owed on the existing mortgage.
b. For example, if the appraised value of your home is $100,000 and the lender decides to discount the value to 80% of the appraised value, the amount of the discounted appraised value is equal to $80,000.
c. If the balance owed on your mortgage is $40,000, this will be subtracted from the discounted appraised value of $80,000, leaving you with a potential line of credit of $40,000.
- In determining your actual credit limit, the lender will also consider your ability to repay the loan (principal and interest) by looking at:
b. debts and other financial obligations
c. credit history.
Q: Earlier you mentioned that a home equity line of credit is similar to a credit card. How does the home equity line of credit differ from a credit card?
- Unlike credit cards, home equity lines of credit usually aren’t open-ended.
- For the first 10 years or so, you can draw as much as you want from your credit limit, and you only need to pay the interest charges.
- In the next stage, the “draw” period ends and whatever debt you have left is “amortized,” which means you need to start paying principal and interest to retire your debt.
- Even if the lender lets you renew your draw period, you eventually have to pay off the debt.
Q: What are some important questions to ask if you determine a home equity line of credit is right for you?
A: If you determine a HELOC is right for you, make sure you find out the answers to these important questions:
- What is the initial interest rate and how will it change over the life of the term of the loan?
a. You may be charged a low interest rate for an initial time period, after which time, your interest rate will increase, thus costing you more money.
b. Ask your lender what to expect so you will be able to anticipate a change in payments.
- Does the rate have a specified minimum and maximum?a. Many lenders will set a floor and ceiling for their interest rates.
b. Ceilings protect you from surges in interest rate environments, while floors protect lenders from drops in interest rates.
- What documentation do I need to provide?
a. You will probably need to submit information about your employment history, income, assets and debts.
- What is the minimum payment required each month?
a. This information is crucial to determining your monthly budget including utilities, groceries and car expenses.
- Does the home equity line of credit expire after a specified term, after which time full payment is required?
a. Know ahead of time if the home equity line of credit expires and you must pay it back in full, so you can be adequately prepared.
- When can I access the funds and do I have to make a withdrawal immediately?
a. This will let you know when you can start using the money from your HELOC.
- How can I access the money? Once approved for a home equity line of credit, you will most likely be able to borrow up to your credit limit whenever you want.
a. Typically, you will use special checks to draw on your line.
b. Under some plans, such as Heritage Federal’s, borrowers can use a credit card, visit a branch location, or even access the line of credit through services such as online banking.
- Do I have to maintain a minimum balance? Make sure you find out what percentage of the line of credit you can access freely.
Q: Are there additional limitations on how a homeowner can use their home equity line of credit?
A: It really depends on the plan.
- Some plans may require you to borrow a minimum amount each time you draw on the line (for example, $300) or keep a minimum amount outstanding.
- Some plans may also require that you take an initial advance when the line is set up.
- It is important to understand all the terms of your plan.
Q: How can a homeowner know if he or she is getting a good deal when borrowing against his/her home equity?
A: Here are some tips to knowing if you’re getting a good deal:
- Compare the rates. The rate you’ll be offered on a loan or line of credit depends heavily on your credit score but there are different offers that can affect the total amount your will owe for using a HELOC.
a. For instance, HFCU currently has a HELOC offer for .99%APR for the first 9 months on balance transfers and initial advances and no closing costs or processing fees.* These benefits along with our usual low rates could save you a significant amount in interest.
- Know the tax rules.
a. Home-equity borrowing is often touted as superior to other consumer debt because you can deduct the interest.
b. But that’s not always true. You have to be able to itemize, which most taxpayers can’t do because they don’t have enough deductions.
c. Even if you do get a deduction, the tax break is limited to interest on loan amounts of $100,000 or less; if you’ve borrowed more, the interest you pay on amounts over $100,000 can’t be deducted.
d. Consult a tax advisor for deductibility of interest.
- Know what you’re risking.
a. A home can be a good way to build long-term wealth — as long as you’re not constantly draining it away.
b. Every dollar of equity you borrow is a dollar that can’t be used to buy your next home when you’re ready to trade up, or to fund your retirement when you’re ready to downsize.
c. Don’t assume that using equity to pay for home improvements or education is always a slam dunk.
d. Not all home improvements add value and it’s easy to go overboard with student-loan debt, as well.
e. It’s up to you to set reasonable limits on your borrowing and to make sure that what you’re buying is worth the wealth you’re committing.
- Keep some headroom.
a. You should try to keep a cushion of at least 20% equity in your home. If your combined mortgage and home-equity borrowing exceeds 80% of the value of your home, you’ll pay higher interest rates.
b. You’re also cutting yourself off from an important source of funds in an emergency.
* APR=Annual Percentage Rate. Offer subject to credit review and approval. Loans must be originated between June 1, 2017 and December 31, 2017 and closed before January 31, 2018. Offer only available on new Heritage Federal Credit Union Home Equity Lines of Credit. The applicable interest rate varies depending on your credit qualifications and loan-to-value ratio. When opened, the introductory rate is 0.99% APR for the nine (9) months on balance transfers and initial advances. For a Heritage Federal Credit Union Home Equity Line of Credit, your adjustable rate will be determined by the loan-to-value of your home with rates starting as low as Prime Rate -.25% (Currently 3.75% APR) with a maximum APR which will not exceed 18.00% and a rate floor of 3.00%. Interest rates may vary and if changes occur, they will be on the first day of the month. Interest Rates are indexed to the Prime Rate as published daily in The Wall Street Journal “money rates” column. As of 05/19/2017, the Prime Rate is 4.00%. Offer is available on Heritage Federal Credit Union Home Equity Line of Credits only. Processing fees of $150 are waived if advance of $10,000.00 or more is obtained at the time the account is established. The maximum loan amount is up to 90% of the value of the borrower’s residence not to exceed $200,000.00, if the loan-to-value is over 80% then the maximum loan amount is $50,000.00. Flood and/or property hazard insurance may be required. Other restrictions may apply. Rate and offer are subject to change without notice. Consult a tax advisor for deductibility of interest.