What is Heloc
The 5 letter word Heloc is a one type of loan. It is the shortest form of Home Equity Line of Credit. Often It is called as ‘Home Equity Line’. Heloc is set up as a line of credit rather than for a fixed dollar amount for some maximum draw.
You may borrow $100000 using a standard mortgage and you have to paid out in its entirely at closing. But if you use HELOC for borrowing the same amount, here the lender’s promise to advance you up to $100000 and the time and amount will be as per your choice. By writing a cheque or using a special credit card or using other ways you can draw on the line. Most of the HELOCs belongs to the second mortgages. Whenever you need to refinance your existing first mortgage which is more than one or in short as increasing number, you can use it as second mortgage and it is the substitute for the first mortgage. Most people use HELOC as a substitute for the first mortgage to save a lot of money in short terms but it is not a simple process as having a lot of risks.
HELOC have a Draw Period of usually 5 to10 years, and within this time the borrower is only required to pay the borrowing amount interest. HELOC also have a Repayment Period and within this interval it must be repaid. This Repayment Period are usually given from 10 to 20 years by the mortgage company and during this interval the borrower must make payments of the principal amount which is equal to the balance at the end of the draw period that is divided by the number of months in this repayment period. In case of some HELOCs, they offer that the entire balance be repaid at the end or the closing year of the Draw Period, with this the borrower have to refinance at that point.
There are certain points regarding HELOC as follows -
Interest of a HELOC
The interest of the HELOC is calculated daily rather than monthly as because the balance of the HELOC may vary Day to Day and it also upon the draws and repayments. If the borrower borrows HELOC at a 5% rate, then interest for a day is .05 divided by 365 or .000164, which will be multiplied by the average daily balance during the borrowing month. If someone borrow amount of $50000 at a daily interest of $12.78 then for a 30 days’ month the interest amount will be $383.4 and for 31-day month, the interest rate will be $396.18.
In a simple short on a standard 5% mortgage, at the end of the preceding month an interest that will be given by the borrower for the one month is .05 divided by 12 or .005 iwch will be multiplied by the loan balance.
APR on a HELOC
the interest rate, period is the APR on a HELOC. The APR for a standard load is far different from the APR on a HELOC. APR on standard loan reflect points or other upfront costs, whereas APR on HELOC doesn’t reflect in this.
Benefits of HELOC
For funding intermediate needs such as making home improvement, paying college tuition or any other transaction payed by credit card, HELOCs are convenient for such type of transactions. The major benefit of HELOCs are you can withdraw and make payment of the interest only when you need, just like it is an extra benefit. The upfront cost of HELOCs are relatively lower than that of standard loan. On a $100,000 HELOC, costs seldom exceed $1,000 but in many cases without a rate adjustment the lender paid the amount. Whereas On a $150,000 standard loan, settlement costs for the borrower may range from $ 2-5,000 until the borrower pays an interest rate that is high enough to the lender to pay partial or all of it. The borrowers who draw a large amount at onetime, some HELOCs are convertible into fixed rate loans for this type of borrowers at the time of a drawing.
Risks in case of HELOC
As HELOCs have tendency of exposure to interest rate risk, it is the major disadvantage of the HELOC.
HELOCs as well as Standard loan have Adjustable Rate Mortgages (ARMs) but the HELOCs ARM is much riskier than that of a Standard Loan. HELOCs always changes the market impact very quickly. Like if the prime rate changes on 31st January, the rate of HELOC will be changed and will be effected from 1st February.
In the other hand, HELOCs have no adjustment caps(some exceptional cases are there with having maximum rate like 18%) and in case of Standard ARMs there is rate adjustment rates with having maximum rates 5-6% above than the initial rate.
HELOCs in financial crisis
another risk in HELOCs The financial crisis that erupted in the late 2007 revealed, that the lender has the right to cut an unused credit line.