A “HELOC” stands for Home Equity Line Of Credit. This type of loan is set up as a line of credit with a maximum draw, rather than for a fixed dollar amount. HELOC’s are secured as a mortgage with an interest-only payment. The payment is based on how much credit is used and can fluctuate based on Prime Rate. HELOC’s have an interest-only payment period normally 5-15 years followed by a fixed payoff period. Most repayment periods are usually 10 to 20 years, during which the borrower must make payments to principal equal to the balance at the end of the draw period divided by the number of months in the repayment period. These types of loans are very similar to a credit card where the credit revolves as you payoff principal and then it can be used again. The interest paid on a home equity line of credit is tax-deductible; however, it’s always best to consult your tax advisor.
HELOC’s are convenient for a variety of different needs, such as paying off high interest rate credit cards, paying for your children’s education, cash-out for unexpected emergencies and making home improvements. All you have to do is to draw out the funds and pay interest on only what you need. HELOC’s can be paid off without any penalty and upfront cost is always low. This loan is considered a second mortgage; however, today, this product has become increasingly popular as a first mortgage.
The only disadvantage of a HELOC is the interest rate risk. All HELOC’s are adjustable rate mortgages. Changes in the market can impact a HELOC quickly. For example, if the prime rate changed today, the HELOC will change immediately effective the next day. In 2003, the prime rate only changed once. However, as recently as 2001, the prime rate changed 11 times ranging between 4.75% and 9%. There is a maximum rate of 16% in North Carolina.
Home Equity Loan:
A Home Equity Loan is a secured loan with a fixed amount of money repayable over a fixed number of months. Home Equity Loans normally have terms ranging from three to thirty years. There is only one fixed rate option which follows a fixed payment. Unlike a HELOC, one cannot borrow against this loan. These loans may also be used for paying off high interest rate credit cards, extra cash and making home improvements. Interest rates on home equity loans are typically higher compared to HELOC’s. The payments made to a home equity loan include both principal and interest, unlike a HELOC, which is only interest. As a result, these loans, with a higher payment can be paid off in a shorter length of time.
Home Equity Loans are a popular option in avoiding Private Mortgage Insurance (PMI). In today’s society, consumers have become increasingly conservative when it comes to making a down payment on a new purchase. With interest rates being at a 45 year low, buyers have been able to put less down on their new purchase and still have affordable payments. This allows a new buyer to save more money and use the extra cash to spice up their new home. One may ask, “How does this save me from paying (PMI), if I’m only able to afford a five percent down payment?” The answer is simple. As long as your first mortgage is at 80% of equity, you can then finance a home equity loan or a HELOC up to 95 percent and avoid (PMI). Private Mortgage Insurance only affects those loans in a first equity position. Yes, there will be two secured loans on your investment; however, the savings will be visible immediately. This financing strategy has become a very popular option with (PMI) percentages increasing over the last few years.
