Home Equity Line of Credit - Prepayment Penalities?

For the most part, homeowners are familiar with home equity loans and home equity lines of credit. With either option, you are able to acquire funds for emergencies, home improvement projects, etc. Getting a line of credit and using your home’s equity to your advantage is a huge benefit to owning a home. However, before completing the credit application, homeowners should carefully read and understand the credit line agreement.

How Does a Home Equity Line of Credit Work?

A home equity line of credit is a credit line that is based on your home’s equity. For example, if you owe $80,000 on a $120,000 mortgage, your home’s equity is $40,000. When applying for a home equity line of credit, the lender will approve you for a credit line up to the amount of your home’s equity. Lines of credit are slightly different than home equity loans. While home equity loans are also based on your home’s equity, homeowners obtain a lump sum of money upon approval of their loan application. These loans are generally based on a fixed rate, whereas lines of credit have variable rates.

How to Obtain Funds with a Home Equity Line of Credit

Getting money from your home equity line of credit is very simple. Once a lender approves your line of credit, you will be issued a checkbook or ATM card. Whenever you need cash, you simply write yourself a check from your credit line. Because the amount you withdraw from a line of credit varies, your monthly payments will also vary. If you prefer a predictable monthly payment, a home equity loan will best suit your needs.

Home Equity Line of Credit Prepayment Penalty

Home equity lines of credit have specific terms. Your lender may approve your line of credit for 10 to 25 years. At the end of the term, you must re-apply to obtain another credit line. Home equity lines of credit are similar to other mortgage loans in regards to prepayment penalties.

Before applying and accepting a lender’s offer, carefully review the offer and inquire of prepayment penalties. With a prepayment penalty, you are charged a fee if the credit line is closed before the end of the term. Typical fees are about $500. However, if the balance on your line of credit is zero, but the account remains open for future withdrawals, prepayment fees will not apply.

Home Equity Line of Credit - Great for Remodelling

Many homeowners are lucky enough to find a house that represents exactly what they want in a home. They buy it, make the payments on it, and live more or less happily ever after. Others are not so fortunate. Some buyers who live in a pricey market may have to settle for less house than they need, hoping to find a solution to their lack of space later. A third group of buyers may find that their housing needs change over time, as their family size increases. What can be done in these situations?

A common solution to these problems is to add on to the house, often accomplished by converting a garage to a room, adding a room over the garage, or simply adding a room somewhere else on the property. For these projects, a home equity loan is a great source of financing. The home itself is used as collateral for the loan, and the addition actually increases the value of the house. As most of these projects involve a fixed cost, the payments can be structured at a fixed interest rate over a specific period of time. But what about the do-it-yourself project? What if the problem with the home isn’t a lack of space, but a lack of taste on the part of previous owners? Is there a better financing choice in these situations?

If your problem is gold appliances, lime green carpet, and smiley face wallpaper, you may be looking at a remodeling project of indeterminate duration. For such a project, a better financing choice would be a home equity line of credit, or HELOC. A line of credit offers greater flexibility, both in interest rates and repayment terms, than a traditional line of credit. The loan amount is based on the amount of equity in the home, but the funds aren’t dispersed all at once. Instead, the borrower is given a checkbook, a special credit card, or both and can use them to draw upon funds at his or her leisure. Payments only apply when money is actually borrowed, and the repayment plans can be arranged with both fixed and adjustable interest rates, depending on the lender. This is ideal financing for someone who has purchased a fixer-upper home that needs a variety of changes, repairs, or modifications. The credit card can easily be used to purchase paint, drapes, flooring, appliances or whatever the homeowner requires to make the home fit their needs.

If you just need to hire a contractor to add a gameroom to your home, a traditional home equity loan would work well. For ongoing projects with indefinite timeframes and budgets, a home equity line of credit may be the best choice.

Home Equity Line of Credit - Pros & Cons

A home equity line of credit or HELOC is based on the equity of your home. The equity in your home is the total value of your home minus the mortgage and/or lien. The home equity line of credit is used just like a credit card. You are given a set sum amount which you are allowed to draw from. There are both pros and cons to weigh when deciding whether or not a home equity line of credit is the right choice for you. The following is a list of some of the pros and cons of a HELOC.

Pros
* HELOC’s usually offer a lower interest rate than other loans and/or credit cards.
* The costs of obtaining a home equity line of credit are relatively low.
* Home equity lines of credit can be used for debt consolidation, home improvement projects, college tuition, the purchasing of a new auto or even a vacation.
* The HELOC is an excellent option for short-term financial needs.
* A home equity line of credit allows the borrower to have some flexibility when it comes to repayment since the borrower is only repaying the amount which was borrowed.
* Home equity lines of credit lets you borrow only the amount that you need.
* HELOCs can be a good source for funds in case of emergencies

Cons
* Since the HELOC is considered to be a second mortgage, the rate is higher than a fixed-rate mortgage, making the loan somewhat riskier for lenders to recoup their investment.
* A higher interest rate means higher monthly payments.
* If you take out a home equity line of credit and fail to make your payments, then you put your home at risk for foreclosure.
* The interest on HELOCs is not the same as the interest on a primary mortgage.

Things to Do With Your Home Equity Line of Credit

If you are wanting to get a home equity loan, rates are still low enough that you may want to make use of that equity in your home. Do you need some ideas on what you could do to multiply your equity or make some extra money off of the capital that could be available to you?

Here are some suggestions of ways to put the equity to good use when you go to take out a home equity or cash out refinance loan.

1. Do a home improvement that will increase the equity in your home more than the cost of doing the improvement. As an example, I have heard rumors that adding a deck to a home, because of the amount it increases the homes resale value, can add up to 4 times the cost of actually installing the deck.

2. If you have a low interest rate on your home, invest your equity in a low risk investment that has a much higher return on your money.

3. Buy an existing business or start a new business with the equity capital in your home. If you can start a low risk business, take the opportunity to let your equity work for you.

4. Use the equity as a down payment on an investment property or a rental.

5. Use it to consolidate high interest debt and possibly save yourself hundreds of dollars a month to put toward something else.

6. Use it to finance your education and increase your earning power.

7. If you live in an area zoned for this, you could finish a basement or area of the house to rent out. You could create a separate living space or apartment on your property.

Just be careful to not do anything risky with the equity in your home. If you can get a low enough rate, it may be worth taking that money and investing it somewhere else.

10 Things To Look For In a Home Equity Line of Credit

If you are a homeowner, you’ve probably received offers to apply for a home-equity line of credit (HELOC) loan. Handled with care, HELOC loans can be an excellent way to improve financial flexibility, provide readily available cash reserves for emergencies, or pay for large expenses (like college tuition or home improvements) that have irregular payment schedules. But be aware that not all home-equity credit lines are created equal. If you decide that a HELOC is right for you, what features should you look for? Here are ten things that should be at the top of your list:

1. No application fee (or fee should be refunded at closing – The HELOC loan market is very competitive. Some lenders may charge a fee to help cover their costs of processing your HELOC application and to ensure applications are received only from seriously interested homeowners. If your lender assesses an application fee, be certain that it is refundable at closing. Otherwise, look elsewhere for your HELOC loan.

2. No appraisal or closing costs – The market value of your property is key to determining the amount of your credit line. Some lenders are willing to use publicly available tax assessment data in lieu of formal appraisals. Others may absorb appraisal costs to attract customers. Either way, there are enough no-cost options available that you should not have to settle for HELOC lender that charges appraisal costs or any other closing costs.

3. No account maintenance or check-writing fees – Lenders obviously make their money when you write checks (borrow) on the home-equity credit line. Most lenders make it as hassle-free as possible with free checks and, sometimes, even debit cards. If your lender charges fees for the privilege of having a HELOC checking account, look elsewhere.

4. No "non-usage" fees – On the other hand, a few lenders have started assessing fees to homeowners who take out home-equity credit lines but don’t use them enough! Apparently they don’t approve of the notion that a homeowner may want to have a HELOC as an emergency “reserve” account. Definitely look for a lender that does not charge this type of fee.

5. Variable APR equal to or near the prime rate (adjusted quarterly) – The only cost involved with a good home equity credit line should be interest charged (APR) on the balance borrowed. As with any loan, the borrower’s goal is to get the lowest possible APR. Most lenders use the “prime rate” as published in the Wall Street Journal (or other publication) as a base index and charge you an APR equal to prime plus or minus a marginal percentage (e.g. 0.25%). Search for the best rate available, but be aware of low “teaser” rates that may suddenly change after a brief introductory period or be accompanied by special fees. Also, keep in mind that the periodic and lifetime caps on rate changes are as important as the initial rate (see below).

6. Periodic cap on interest rate changes (the amount that the rate can be changed at one time) – Virtually all HELOC loans are variable rate loans meaning that the initial interest rate (APR) will change at some point as surely as the weather. A key is to understand how often the rate can adjust and how much the rate can be adjusted at one time. Of course, when rates are falling the larger and faster the change, the better for you. But more important is the upside risk you face when rates are rising. Look for a HELOC that adjusts quarterly (rather than monthly) in increments of 0.5% or less. Note: with expectations of rising interest rates, many lenders appear to be eliminating the periodic rate cap feature and raising lifetime caps to legal limits. If you have an older HELOC that incorporates relatively low rate ceilings (or if you find one), consider yourself fortunate!

7. Lifetime cap on rate increases (the amount that the rate can be adjusted over the loan's life) – A good HELOC is something you’ll want to keep for awhile. Although interest rates have been at relatively low levels for a number of years, it wasn’t too long ago that a 10% loan was regarded as a bargain! The point is that interest rates over time can rise dramatically. You’ll want to find a HELOC with a lifetime rate cap that you can live with. Ask your loan officer to clearly spell out the “worst case” scenario for rate increases for the HELOC you are applying for.

8. Ability to convert to a fixed rate loan – When rates do rise, people often get skittish about their variable-rate debt. A useful feature to look for in a HELOC is the ability to convert the line of credit to a standard fixed-rate, fixed-term home-equity loan (HEL). You likely won’t get an APR as favorable as a newly issued HEL, but you also won’t have appraisal or closing costs to pay if you convert. However, note that many lenders charge a fee for converting to a fixed rate loan.

9. Interest-only payments allowed – It is usually best to make regular principal payments on your HELOC balance. Yet a job loss or other emergency can make it a challenge to keep payments current. In these situations it is nice to have the flexibility to lower your HELOC payment as much as possible without increasing your loan balance or raising red flags at the credit rating agencies.

10. Unrestricted ability to repay principal without penalty – On the other hand, you also want the flexibility to pay down principal on the loan when you choose. You may get a bonus from your job that you want to apply to the loan or you may find a 0% balance transfer offer that is worth taking advantage of. In any case, a key component of a good HELOC is the unfettered ability to repay principal.

Shop around and you will be able to find a HELOC loan with many (if not all) of these features. Keep in mind that your bank is not the only game in town. Credit card companies, mortgage bankers and brokerage firms have all entered the market and offer competing products. Credit unions typically offer excellent terms and should not be overlooked. Also, there are many reputable on-line sources that have lower overhead costs and may be able to offer better terms than the local bank.

5 Tips for Savy Use of Your Home Equity Line of Credit

Tapping your home’s equity to pay college expenses, consolidate credit card debt or even to buy a new car or boat is common place. Many economists attribute the additional buying power afforded consumers through home equity debt as a primary reason the nation’s economy has been able to emerge from the recent recession. Yet, aside from simply allowing consumers to spendmore, the flexibility and efficiency of a home equity line of credit (HELOC) can provide the financially savvy person with the means to savemoney, make money or simply take advantageof opportune situations he or she might otherwise miss out on. Here are five tips to show you how:

Tip 1: Take Advantage of Higher Insurance Deductibles!

You probably know that raising deductibles on auto and homeowners insurance policies can mean big savings on insurance premiums. If you increase the deductible on a homeowner’s policy from $500 to $1,000, you'll cut your premium by as much as 25%!

Yet many people don't do this because they fear they may not have the necessary cash available in the event of a loss. With low-interest cash readily available through a home equity line of credit you'll have the security and confidence you need to raise your deductibles and reap the savings!

Tip 2: Lock In Big Savings!

Credit card companies (e.g. the GM card) frequently have shopping programs with names like "Main Street Savings" on a 30-day free trial basis. These programs allow you to buy discounted gift cards (20% discount) for major national retailers like Target, Sears, and Home Depot.

The flexibility afforded by a home equity line of credit can allow you to purchase (during the free trial period) a large amount of discounted gift cards for major retailers you frequent. Then use these cards instead of cash or credit when you purchase everyday items (The cash you would have spent can be used to pay down the HELOC). Although you pay low interest on the home equity credit line, you receive a front-end discount of 20% on everything bought. When combined with store coupons and sales, you can realize total savings of 70% or more!

In short, a HELOC provides the low interest cash availability to take advantage of bargains like this that you might otherwise have to pass on.

Tip 3: Take Advantage of 0% Balance Transfer Offers!

We’ve all seen no-fee credit cards offering "0% APR" on balance transfers for 6, 12, and even 18 months. If you have a balance on your HELOC, you may be able to take advantage of these offers. Here’s an example of how: last year I accepted such an offer and promptly transferred $10,000 from my home equity credit line balance (which had a 4.25% rate). Then I cut up the card!

For the next eleven months, I paid the monthly minimum credit card payment (3% of the outstanding balance) by writing a check from my home equity line of credit. In the twelfth month, prior to the expiration of the 0% offer, I paid off the remaining balance with another home equity credit line check. During the 12 months, I also made sure to continue my regular payment towards the HELOC at the same level, meaning that more of each went to pay down principal and less went to interest.

Net result: interest savings of over $350.00, lower principal balance on my HELOC, and a positive addition to my credit repayment history!

Tip 4: First Pay With a Rewards Credit Card!

If you're contemplating using your HELOC for a major purchase, you should consider whether or not the merchant you are dealing with accepts credit cards. Why? Because it makes a great deal of sense to pay first with a rewards credit card and then pay off the card with your HELOC check. On a recent $14,000 bathroom remodel, I was able to charge plumbing services, cabinets, and almost everything else to my Fidelity/MBNA 529 College Rewards MasterCard. This card pays you back by putting 2% of everything charged into a 529 college savings plan. Result: $280.00 in college savings that would have been missed if I paid the bills directly with home equity credit line checks!

Whatever rewards credit card you favor, it's sensible to pay first with the card whenever possible. Keep in mind, though, you must promptly pay off the balance and not incur finance charges.

Tip 5: Replace Your 1st Mortgage with a HELOC Loan

According to Money Magazine, if you have more equity than debt and plan to stay in your home for 3 years or less, you should consider replacing your first mortgage with a home equity line of credit. HELOCs are currently available around the country at rates of 4% or lower.

Even if rates increase a full percentage point each year, they'll still be low when you pay off the loan. Best of all, there are no closing costs with most HELOC loans so you won't have to worry about recouping them through interest savings as you do with a traditional mortgage refinance.

A savvy person – using tip 3 in conjunction with tip 5 - might even move a portion of his mortgage to a 0% credit card thanks to the flexibility of a home equity line of credit.

Decision Time

Home equity loans and home equity lines of credit continue to grow in popularity. According to the Consumer Bankers Association, during 2003 combined home equity line and loan portfolios grew 29 percent, following a torrid 31 percent growth rate in 2002. With so many people deciding to cash in on their home’s equity value, it seems sensible to review the factors that should be weighed in choosing between out a home equity loan (HEL) or a home equity line of credit (HELOC) loan. In this article we outline three principal factors to weigh to make the decision as objective and rational as possible. But first, definitions:

A home equity loan (HEL) is very similar to a regular residential mortgage except that it typically has a shorter term and is in a second (or junior) position behind the first mortgage on the property – if there is a first mortgage. With a HEL, you receive a lump sum of money at closing and agree to repay it according to a fixed amortization schedule (usually 5, 10 or 15 years). Much like a regular mortgage, the typical HEL has a fixed interest rate that is set at closing for the life of the loan.

In contrast, a home equity line of credit (HELOC) in many ways is similar to a credit card. At closing you are assigned a specified credit limit that you can borrow up to - not a check. HELOC funds are borrowed “on demand” and you pay back only what you use plus interest. Depending on how much you use the HELOC, you will have a minimum monthly payment requirement (often “interest only”); beyond the minimum, it is up to you how much to pay and when to pay. One more important difference: the interest rate on a HELOC is adjustable meaning that it can - and almost certainly will - change over time.

So, once you’ve decided that tapping your home’s equity is a smart move, how do you decide which route to go? If you take time to honestly assess your situation using the following three criteria, you will be able to make a sound and reasoned decision.

1. Certainty or Flexibility: Which do you value the most?

For many borrowers, this is the most important factor to consider. Your home is collateral for either type of home equity borrowing and, in a worst case scenario, it could be seized and sold to satisfy an outstanding unpaid loan balance. People do remember the double-digit interest rates of the early 1980’s and, for many, the mere prospect of interest costs on a variable-rate home equity line of credit rising rapidly beyond their means is reason enough for them to opt for the certainty of a fixed rate HEL.

From the borrower’s perspective, “certainty” is the main virtue of a fixed-rate home equity loan. You borrow a specific amount of money for a specific period of time at a specific rate of interest. You repay the loan in precise monthly installments for a precise number of months. For many, knowing exactly what their future obligations will be is the only way they can borrow against the equity in their home and still sleep at night.

A home equity line of credit, in contrast, is short on certainty but long on the virtue of flexibility. With a HELOC loan you borrow funds on an irregular schedule that meets your needs at adjustable interest rates that can change quickly. Loan repayment is also flexible: you typically are required to make only relatively small “interest-only” monthly payments on a HELOC. However, you have flexibility to make any size payment above the interest-only minimum or payoff the loan at your will.

2. Do you need money for a one-time, lump-sum payment or will your cash needs be intermittent over several months or years?

Home equity loans are best suited for one-time payment needs (a good example is consolidating debt by paying off several high-rate credit cards at one time). This is because at the time you close on a HEL, you will be provided with a lump-sum check in the amount you’ve borrowed (less closing costs). While it may be empowering to have that much money handed over to you, be humbled by the fact that you will immediately begin incurring interest costs on the entire balance.

When you close on a HELOC loan, on the other hand, you will be given a checkbook (or debit card) that you use only as needed. So, for instance, if you're embarking on a multiyear home improvement project for which you'll be writing checks at varying times, a HELOC might be best. Similarly, a credit line is probably best for paying sporadic college expenses. Interest on a HELOC loan is only charged from the time that your HELOC checks clear the bank and only on amounts actually disbursed… not the value of the entire credit line.

3. Do you possess sufficient financial self-discipline for a HELOC?

Financially-disciplined borrowers can have the best of both worlds…almost. By taking out a HELOC loan but paying it back according to a self-imposed fixed amortization schedule they can enjoy both the flexibility of borrowing cash only as needed and the certainty of a fixed repayment schedule. HELOCs are typically more efficient in terms of lower closing costs and a lower initial interest rate. Also, a HELOC may be somewhat easier for borrowers to qualify for since the low, flexible monthly payments mean debt to income ratios that loan officers look at are more favorable for the borrower.

The one big factor not within the HELOC borrower’s control is the interest rate (see 1 above). Interest rates will almost certainly change over the life of a HELOC. This means that a self-imposed “fixed” amortization schedule may need to be periodically refigured. Numerous internet sites provide free, powerful mortgage calculators that can assist you in preparing updated amortization schedules whenever needed. Some lenders are also meeting borrowers’ demand for greater certainty by providing HELOC products that can be converted (for a fee) into a fixed rate loan when the borrower elects.

As mentioned earlier, HELOC loans are much like credit cards and the similarity extends to spending temptation. If you are a person who has trouble keeping credit card debt under control and you haven’t taken steps to change habits, then a HELOC probably isn’t a smart choice.

You might be wondering which home equity product most people actually choose. According to the Consumer Bankers Association 2002 Home Equity Study, home equity lines of credit account for 28 percent of consumer credit accounts followed by personal loans (23 percent) and regular home equity loans (16 percent). In terms of dollar value, home equity credit accounts (HELs and HELOCs together) represent a full 75 percent of consumer credit portfolios with HELOCs having a 45 percent share of the market and HELs a 30 percent share. Of course, the popularity of HELOCs may subside if interest rates continue to rise.

Whichever home equity product you decide on be certain to shop for the best deal possible. The market is extremely competitive and there are many non-traditional options, including on-line lenders and credit unions, which should be considered in addition to your local bank.