HELOCs - Everything You Need To Know

Home Equity Lines of Credit, or HELOCs, are a loan instrument used to access your home equity.

I want to address what they are and then how to get them.

First, a HELOC does not function like a regular mortgage. It is not an installment loan. But it IS a lien against the title to your house, just like a regular mortgage is. And if you fail to make your payments on time you can lose your house to foreclosure. A HELOC can be charged up and paid off and charged up again just like a credit card. As long as you have equity you should be able to secure a HELOC. BUT not every lender will give you access up to 100% of the value of the house. We’ll talk about who does in a sec.

The rates on HELOCs are typically based on the prime rate and are typically variable. Look into the prime rate to learn about it. But the prime rate is directly tied to the actions of the Federal Reserve and has no limitations to its movement. The Feds typically move their rate in order to facilitate or restrict growth or inflation in the national economy. And they typically telegraph their intentions quite a lot. Normal mortgages are not usually based on the prime rate so this is an important difference.

Another interesting characteristic of HELOCs would be that when securing them, the banks or credit unions don’t typically charge any fees for them. They sometimes charge for the appraisal, but often that’s covered by them. However, when you pay them off, especially through a refinance or sale, you need to sign a form requesting it to be closed. Oftentimes, this comes with a penalty if done within the first few years. I’ve seen penalties as much as $250.

Now, when you want a HELOC, shop around, a lot! You need to know a few things to do so. How much $$ do you want? What’s your credit score? What’s the value of your house? I think all banks and credit unions will go to 80% of the value of your house (minus the 1st mortgage), but do you want more than that? If so, that’s the first question to ask when calling around, what’s the highest LTV (loan to value ratio) you’ll lend to? Once they answer that, verify that the size of the HELOC that you’re wanting is allowed, so what’s your max loan amount at that LTV? For example, I know of several CUs that’ll go to 100% but their HELOC line limit is $20k. So clarify that their rules will work for you. Next ask about fees, do they charge any up front or at closing? Most don’t. But some charge for the appraisal. Now that you have the loan size, and the LTV, you can ask about rates. Don’t get confused in their temporary incentives. Another important question to ask is how they calculate their monthly payments that are due. Most will offer interest only payments. But some have very strange repayment options that make the payments very large! Ask about any ongoing fees or annual fees so you know what to expect. Lastly, be sure to ask about timing. How long will it take them to process your loan? I would personally call around until I got 5 that did what I wanted. I’d apply with my favorite three. And once they all processed my loan and asked me for conditions, I’d close the one I liked the best.

Last thing I’ll add, you may want to research an interesting strategy using these HELOCs. Some people will secure a HELOC and then stop using their checking and savings accounts. Some call it Velocity Banking. They’ll connect all their auto pays, direct deposits, etc. to their HELOC. HELOCs work on daily interest so you only pay interest for the balance you have that day. So when you receive your paycheck into your HELOC, the balance drops a lot. Then as you begin paying your bills, the balance rises back to close to where it was. But you saved interest while the balance was lower and growing. Also, most of us need to pay off our debts. We see a balance and we just want to pay it off. So seeing a balance on a HELOC drives us to scrimp and save a little more and spend less so the balance can be reduced. The combination of this and saving interest tends to make this a decent strategy for some. But I’m not a financial planner, so do your own research to find out if it is a good idea for you and your family.