If you have made the decision to apply for a home equity line of credit (HELOC), then familiarizing yourself with its features will simplify the application process. In addition, when you draw against the loan, you will know how that loan works and what to expect.
Features to understand when applying:
Your home must have equity available in order to qualify for a HELOC. The amount of the outstanding mortgage must be less than the value of the home. Many banks will loan you up to 80% of the home value less the amount you owe. In addition, the lender will consider your payment history, monthly income, employment history and monthly debts.
The index is a financial benchmark used by lenders to set interest rates on most consumer loan products. Many lenders use the Wall Street Journal prime rate.
The margin is the premium added to the index to calculate the interest rate for the HELOC.
The bank will use a standard calculation to determine your credit limit. For example, if the bank allows a maximum limit of 80% of the home’s value and your home appraises for $425,000 with a balance of $130,000, then the credit line would be for $210,000 ($425,000 x 80% = $340,000 – $130,000 = $210,000).
The Draw Period
The draw period is the length of time during which you can take out money against the equity in your home. Draw periods can vary between banks and individual situations; however, most HELOCs have a 10 year draw period. Your bank will issue HELOC checks or an access card to use the line of credit. Or your bank may give you access through online banking. After you access the line of credit, you receive a monthly bill with a minimum payment. Some lines of credit have a minimum monthly payment that covers only interest; therefore, it is prudent to predetermine if this is the case for your HELOC.
The lender will charge interest on any amount you draw against your HELOC. Because many home equity lines of credit carry variable interest rates, the amount owed each month may change. A HELOC is a home loan, and the interest paid is typically tax deductible, although it is wise to double check with a tax advisor about your individual situation. In addition, most banks have the right to decrease the line of credit with proper notice, and some home equity lines of credit contain an option to convert all or part of the variable rate balance to a fixed interest rate.