HELoan vs HELOC

• By Admin
• October 18, 2013
• Comments Off on HELoan vs HELOC

Home Equity Loan and Home Equity Line of Credit (HELOC) are mortgages which use a house as collateral. Unless there is currently no mortgage on the house, home equity loan and line of credit are usually second mortgages behind a first mortgage.

Home Equity Loan is much like a first mortgage, after the mandatory rescission period (three days after settlement), the homeowner is mailed a check of the loan amount less closing costs, if any, in lump sum.  Thereafter, the homeowner makes fully amortized, equal monthly payments for the loan term, usually 10, 15, 20 or 30 years. Home Equity Loans have fixed interest rates, that is, the interest rate is unchanged throughout the life of the loan.

For example, a homeowner gets a Home Equity Loan in the amount of $150,000 with a 15 year term at 8.25% interest rate. The bank mails to him a check of $150,000 (assuming no closing costs is charged to the homeowner) three days after closing. Starting the following month, the homeowner makes equal monthly payments of $1,477 for 15 years to repay the Home Equity Loan.

Home Equity Line of Credit works much like a credit card. It is a revolving line of credit. After the rescission period, the homeowner is mailed a check book. He can write checks to himself whenever he needs to borrow against the credit line. The interest rate on HELOC is adjustable, usually pegged to the Prime Rate. Interest is charged on only the amount owed. Required monthly payment is only the interests owed for the month. Of course, the homeowner can choose to pay more or pay off the entire loan any time. Most HELOC’s have a 10-year “draw period” (the time during which the homeowner can borrow money from the Home Equity Line, up to the line limit) and a 20-year “repayment period” (during which no more borrowing is allowed). Most banks charge an annual account maintenance fee for HELOC.

To further illustrate how a HELOC works, assume in March a homeowner gets a Home Equity Line of $150,000 at Prime Rate. After the rescission period, the bank mails to him a check book. On June 1, he writes a check in the amount of $40,000 for a home improvement project. Assuming the Prime Rate is 8.0%, on July 1 his required interest-only payment is $266.67 ($40,000 X 8% divided by 12 months). After making the interest-only payment, the outstanding balance remains to be $40,000. On July 2, the homeowner writes a check of $35,000 to purchase a new vehicle. A month later, on August 1, the required interest-only payment is $500 ($75,000 X 8% divided by 12 months). After making the interest-only payment of $500, the outstanding balance will still be $75,000. On September 1, assuming the prime rate is at 8.25%, the new interest-only payment is $515.63 ($75,000 X 8.25% divided by 12 months). On September 2, the homeowner repays $20,000. The interest due on October 1 will be $378.13 ($55,000 X 8.25% divided by 12 months). On October 1, he chooses to pay of the entire outstanding balance of $55,378.13. No payment is due on Nov 1. He can borrow against the Home Equity Line of Credit as often as he needs, up to $150,000, during the “draw period”.