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Overview
What Terms Are Typical for Home Equity Lines of Credit?Home equity lines of credit, or HELOC, can be a useful financial management tool for individuals and small business owners. HELOCs enable a homeowner to access the equity in his home to meet financial obligations by simply writing a check, in most cases. Unlike a fixed mortgage, the terms of a HELOC vary from year to year, depending upon the prevailing interest rates on or near the anniversary date of the opening of the HELOC. Also, HELOCs are a form of revolving credit, so once the line of credit is repaid, the homeowner can again access the equity in his home without opening a new HELOC.
History
The genesis of HELOCs was based in the business world. For decades banks set up lines of credit for businesses to provide those businesses with an effective means of cash-flow management. Wealthy individuals were also granted personal lines of credit because of their close personal relationships with bank owners and officers. These early lines of credit were unsecured and were, therefore, unavailable to the average consumer.
Banks introduced HELOCs to the general public to capitalize on the exploding home values of the late 1990s and the early 21st century. HELOCs enabled banks to lend more money and generate more interest and fees, with the added protection of holding the customer's home as collateral.
Function
A homeowner applies for a HELOC at his bank. The application begins a process of determining how much the home is worth, what encumbrances currently exist, and what percentage of the remaining equity the bank will allow the homeowner to access. A professional appraisal is ordered and completed, determining the market value of the home. A complete title search is done to determine the total of existing mortgages against the property. The bank then offers the homeowner a credit line based on the remaining equity in the home. Generally speaking, the interest rate will be variable and will adjust with prevailing market conditions on the anniversary of the opening of the HELOC. Once approved, no money actually changes hands. The HELOC is activated when the homeowner draws money from the account. There are often no minimum payments on the line and, if there are, the minimum payment is usually interest only on the amount borrowed. At the expiration of the term, all the money borrowed must be repaid or refinanced. Though a HELOC is considered by many to be a separate entity from a second mortgage, in fact a HELOC is a second mortgage and is recorded as such.
Time Frame
HELOCs are usually amortized for a term of 5-15 years. However, the interest rate almost always will be adjusted on an annual basis. In a rising interest rate environment, HELOC payments can quickly become higher than the payments on a fixed second mortgage of the same amount.
Misconceptions
Even though HELOCs work like a credit card, homeowners must always remember that the loan is secured by their home. While a credit card is an unsecured debt, missing payments on a HELOC can lead to foreclosure.
Expert Insight
When the speculative housing bubble burst in 2008 and sent home values plummeting across the country, most major lenders suspended or froze the home equity lines of credit they had in place with their customers. Foreclosure rates hit all-time highs and banks took tremendous losses. It is for this reason that it will take many years for HELOCs to return to favor.
