If you are a homeowner with a healthy credit score, you’ve probably received offers to
apply for a home-equity line of credit (HELOC). Handled with care,
home-equity credit lines 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
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.
2. No appraisal
or closing costs – The market value of your property is
key to determining the amount of your credit line.
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,
Home Equity Line of Credit (HELOC) versus a Home Equity Loan
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.
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
cap on interest rate changes (the amount that the rate can be
changed at one time) – Virtually all HELOC’s 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!
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.
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.
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.
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
and you will be able to find a home-equity line of credit 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 (e.g. ING Direct) that have lower overhead costs and may
be able to offer better terms than the local bank.
About the Author...
Tim Paul, Michigan
More about home equity credit loans
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Home Equity 101 - Motley Fool.com guide with the basics of HELOC and home equity loans with pros and cons, helpful tips and related resources.