Calculate Your Available Equity
HELOC Structure and Repayment
If you are like most US homeowners, at some point you may consider different ways to use the power of your earned equity. Popular options to harness equity will include a home equity loan, a cash-out refinancing, and a Home Equity Line of Credit, or HELOC.
Consumers enjoy the ability to choose a loan product that fits their needs and situation. By knowing more about each option and how it performs, the borrower can choose the best product for each situation.
Sine HELOCs are always popular and are currently be on the rise, it helps a consumer to understand more about how the repayment process can vary. This article will look more closely at some different types of HELOC options in structure and repayments, so the reader can use the information to shop around for the best possible deal.
Understanding Your Home Equity Options
Home Equity Loans Versus HELOCs
Both home equity loans & home equity line of credit are considered second mortgages. Each allows borrowers to extract equity from their homes at a rate which is typically slightly higher than their first mortgage.
A home equity loan is just like a first mortgage, except it typically is for a smaller sum of money & charges a slightly higher interest rate. The borrow receives the funds immediately & beings repayment immediately on a normal amortizing basis for a term which typically lasts 10 to 15 years.
A HELOC acts more like a credit card. A borrower is authorized to borrow up to a set limit, but is not charged interest until after the equity is extracted. Further, HELOCs can regularly be drawn upon & repaid in part or full to restore the credit limit.
In most cases home equity loans used fixed rates, while HELOCs use adjustable rates which change with economic conditions.
Lenders may choose to freeze or lower the limit on a HELOC if the home's value delines significantly or the borrower has issues with their personal finances which lead the lender to believe they will have difficulty paying off their loan.
We offer a HELOC vs home equity loan calculator to help borrowers evaluate their options.
The following table is useful for comparing the features of different equity options.
| Loan Features | #1 | #2 |
| Fixed APR | ||
| Variable APR | ||
| * Index used & current value | ||
| * Amount of margin | ||
| * Frequency of rate adjustments | ||
| * Amount & length of discount (if any) | ||
| * Interest rate cap & floor | ||
| Length of plan | ||
| Draw period | ||
| Repayment period | ||
| Initial fees | ||
| Appraisal fee | ||
| Application fee | ||
| Points & other upfront charges | ||
| Closing costs | ||
| Repayment terms | ||
| During the draw period | ||
| Interest & principal payment | ||
| Interest-only payment | ||
| Fully amortizing payment | ||
| When the draw period ends | ||
| Balloon payment? | ||
| Renewal option available? | ||
| Lender offers to refinance balance? |
HELOCs vs Cash Out Mortgage Refinancing
As the Federal Reserve has increased the Federal Funds Rate other rates have also lifted. Many homeowners who would have been inclined to do a cash out refinance a few years ago are now more inclined to keep their first mortgage in place at its low rates & use a home equity loan or line to extract equity at the current, higher market rates.
New Lending Limits on Cash-out Mortgages
On August 1, 2019 HUD published an advisory announcing lower loan-to-value limits to mitigate risks from cash-out refinance lending.
- The LTV cap on USDA & FHA loans was lowered from 85% to 80%.
- Ginnie Mae lowered the LTV cap on VA loans from 100% to 90%.
How a HELOC Works
One unique feature of a HELOC compared to other home equity loan products, is the ability to draw out amounts as needed, rather than receiving a lump sum payment. This structure of a HELOC makes it different than other loan options and can be a strategic benefit for the borrower.
The HELOC has two periods, a DRAW period where the borrower can spend up to their credit limit, followed by a REPAYMENT period where the money is paid back. The specific length of each draw and repayment period may vary from lender to lender and even between different lender offers.
Typically, the draw period will be anywhere from 5-15 years, but it could be more, depending on the loan. Usual draw periods are either 10 or 15 years, 10 being the most common. They usually have variable interest rates.
During the draw period, the borrower can use up to their credit limit for any purchase. Funds are typically made available using checks, a special credit card, or internal bank transfers across your accounts with the bank. Some lenders may require each draw on the line to meet some minimum threshold like $300 and/or require a minimum outstanding balance.
Loans secured by dwellings are required to have a maximum interest rate ceiling (which is also referred to as a cap). Some lenders also set a floor rate which prevents interest charges from falling below a specific rate - like 3% APR.
Payments made during the draw period may be interest-only, but you can typically pay down your principal as well and restore the balance to your draw period credit limit. So, if you had a credit limit of $25,000 and used $2500 but paid it back during the draw period, you would restore the full $25,000 in extended credit available.
Some things to consider in evaluating and comparing your draw period:
- How long is the draw period? Can it be extended?
- What are the terms of use – is there a fee for non-usage? A required minimum balance?
- What kind of interest rate is applied?
- How frequently is the rate of interest changed?
- What index & margin are used to establish the interest rate charged?
- Can you repay on principal during draw period?
Lenders’ offers will vary to entice potential borrowers, so be sure you clearly understand the terms and conditions of the draw period.
How much each lender specifically offers, usually depends a lot on the LTV, or loan-to-value limit.
Understanding LTV
Lenders usually offer HELOCs at around 80% LTV. Again, the specific rate may vary but 80-85% is common in today’s offers. So, if you had a home appraised at $500,000 for which you owe $250,000 – you could see the amount available to you at 80% LTV:
$500,000 X 80% = $400,000 minus existing loan balance of $250,000 = $150,000 available
The lender offered 80%LTV($400,000), but with existing mortgage obligations, you can only qualify for $150,000. If you had additional loans on the property, they would be added to your loan balance, and subtracted from the total amount available.
Creditworthiness will definitely affect the offers extended. Borrowers with higher LTV ratios are the ones who have a solid track record with their mortgage history, less credit issues in their past, and display a solid repayment ability.
80-85% LTV is typical for HELOC offers. During stable or strong market conditions, lenders may offer deals with LTV rates of 100% or even 125%, with the additional debt (over 100%) being unsecured. These loans are riskier to both lender and borrower, so they may not always be available, especially in unsteady markets. Such unsecured loans are typically only available to trusted borrowers & charge higher interest rates.
Lenders may offer lower LTV ratios (HELOCs under 80%) to be more inclusive of borrowers with challenged credit or other hurdles that make them more of a credit risk. Conversely, 100% LTV (or more) are HELOC deals typically reserved for those applicants with immaculate credit histories.
As a consumer, you can improve your offers and their range by improving on your personal creditworthiness and paying down more of your existing mortgage. Solid behavior is rewarded in HELOC terms and potential.
Repayment on HELOC
One of the most important aspects of a HELOC to understand, is the repayment period. While a typical draw period might be 10-15 years with a variable interest rate, the repayment period is more likely 15-20 years with a fixed interest rate.
Note that during the draw period, there may be interest-only payments required, depending on your type of HELOC. Most lenders offer these alongside interest+principal HELOCs, so it is your responsibility to choose the right one for your needs.
Realize too, that with interest-only HELOCs, you can typically pay extra toward the principal.
Understand that usually, payments for the repayment period are at least slightly larger than those made during the draw period. Often there is a much greater difference – like doubling payment amounts from the draw into the repayment period. There might be a balloon payment made at the end.
This increase can be a shock to some borrowers, who grow accustomed to the smaller payments required during the draw period. Anticipating the increase can allow you to better plan for it, and to spend more judiciously.
Payments made during the repayment period are amortized, so they will stay the same amount for the life of the loan while the specific amounts of interest/principal paid will adjust over time.
Here is a table which shows the monthly payments on a $50,000 HELOC at various interest rates along with how payments will adjust when the loan shifts from interest-only to amortizing payments.
| Repayment Term | 5% | 7% | 9% |
| 5 years | $943.56 | $990.06 | $1,037.92 |
| 10 years | $530.33 | $580.54 | $633.38 |
| 15 years | $395.40 | $449.41 | $507.13 |
| 20 years | $329.98 | $387.65 | $449.86 |
| Interest-only | $208.33 | $291.67 | $375.00 |
From the above table you can easily see how some borrowers can have trouble coping with increased payments when interest-only payments shift to fully amortizing payments, particularly in a rising rate environment. A borrower who was paying just over $200 in interest each month could suddenly pay nearly $1,000 a month if interest rates spike right as their loan shifts from interest-only to amortizing.
Reducing the outstanding balance on the line during the draw period helps make the adjustment to amortizing payments more manageable. The following table shows how monthly payments adjust based on the balance when a 10-year repayment period begins.
| Initial Balance | 5% | 7% | 9% |
| $50,000 | $530.33 | $580.54 | $633.38 |
| $40,000 | $424.26 | $464.43 | $506.70 |
| $30,000 | $318.20 | $348.33 | $380.03 |
| $20,000 | $212.13 | $232.22 | $253.35 |
| $10,000 | $106.07 | $116.11 | $126.68 |
Some lenders will require a balloon payment be made to extinguish all debts at the end of the loan period, while other lenders will allow borrowers to either refinance the balance, convert the line into a fixed-rate loan, or renew the HELOC. Some lenders also charge an early close fee if the credit line is closed shortly after opening. Be sure you know what options you have avaliable & the associated expenses before obtaining a line of credit.
Cost and Expenses of HELOCs
In addition to the draw and repayment periods, it is important to fully understand any fees and associated costs leveraged by the HELOC lender. Typical closing costs are much less than those associated with home equity loans, and the time to finalize the deal is comparatively short and painless.
It is not unusual for a HELOC to require an initial use at closing. Some lenders may offer at closing a lump sum at a fixed rate to entice HELOC borrowers – but most lenders are going to require some kind of borrowing activity immediately after the HELOC is granted. Fees for non-use are quite common, as may be a minimum balance carried. Cancellation fees are also common. Some lenders might also charge additional fees for each draw.
The flexibility of being able to borrow smaller amounts as needed helps to offset some of the HELOCs costs and risks, but it is incumbent on the borrower to know the specifics and how they apply.
Understanding Stated APR Versus Effective APR
When lenders disclose the annual percentage rate (APR) on a fixed-rate home equity loan the rate reflects both the core interest cost AND any other fees associated with the loan (like points, closing costs, application fees, etc.).
When lenders show borrowers the APR on a revolving credit line it only reflects the core rate of interest charged. They can't show an all-inclusive rate because they do not know how much the borrower will use the line or how rapidly they will repay the line. If a borrwer pays an application fee & an annual maintenance fee to keep a line open but does not use the line then the effective all-inclusive APR would be infinity since they borrowed $0. If a borrower heavily uses a HELOC then the associated application & account maintenance fees would make up a far smaller portion of the total expense.
The following table is a simplified illustration of how account fees can impact the effective APR. It presumes a normal amortizing payment along with a fixed rate of interest for the sake of simplicity & to isolate the impact of the account fees at various loan amounts and loan durations.
| Term | Amount Drawn | Account Fees | Stated APR | Effective APR |
| 15 years | $50,000 | $300 | 7% | 7.0964% |
| 15 years | $20,000 | $300 | 7% | 7.2403% |
| 10 years | $20,000 | $300 | 7% | 7.3365% |
| 5 years | $20,000 | $300 | 7% | 7.6268% |
| 5 years | $10,000 | $300 | 7% | 8.2479% |
| 5 years | $5,000 | $300 | 7% | 9.4743% |
| 5 years | $1,000 | $300 | 7% | 18.6377% |
| 5 years | $0 | $300 | 7% | ∞ |
Best Uses for HELOCs
In addition to understanding the structure of a HELOC and how it differs from other home equity loans, it helps to know whether or not you are using the HELOC strategically.
Because a HELOC allows you to tap varied amounts as needed during the draw period, common uses include:
- Debt consolidation: though rates may be higher than with a home equity loan, the HELOC will be a better option than paying credit card debt
- Home remodeling: pay off contractors, buy materials, and keep home improvements on schedule with a HELOC
- Annual education fees: pay off annual fees to colleges for tuition and housing, handle the ongoing costs of private school or continued education
- Large purchases: HELOCs may be smart ways to buy new appliances or similar, larger-ticket items that can improve daily life
- Rainy day fund: many borrowers use a HELOC to leverage, but leave untapped, some funds for emergencies
Weigh your HELOC’s terms against a home equity loan and a cash-out refinancing to ensure you are taking the best steps forward. Consider closing costs, and time to close.
Think in terms of how much you will spend/need, how soon or often you might need it, and how prepared you are to pay it back. These factors can help you measure different offers to land on the best fit for your situation.
Know too, that all HELOCs are not created equally – different offers will be with different lenders. Shopping around to find your best possible deal is a necessary step of the process.
Account Restrictions
Opening a Line
If lenders change any terms of the line (beyond the variable-rate) before the line is opened they must return any fees you have paid if you decide not to open the line.
The Truth in Lending Act gives homeowners 3 days from the day the account was opened to close a credit line. Simply inform the lender in writing within the 3 day window.
Credit Line Freezes or Reductions
Lenders can lower your credit line if they believe there has been a material change in your financial circumstances which makes the lender believe you will be unable to make payments or the home value declines significantly.
Be sure to monitor your credit score periodically and deal with any data inconsistencies proactively.
If the bank seems like they are being unreasonable when you discuss the issue with them you could look for another lender and use a new line of credit to pay off the old one.
Selling or Renting Your Home
If you are planning on selling your home soon it may not make sense to pay the upfront fees assocated with a home equity loan or line of credit if you have other credit options. When you sell your home you will likely be required to repay the HELOC immediately.
Some home equity lines also prohibit renting the property, so make sure you look for those types of restrictions if you were potentially planning on moving or renting out the property.
Glossary of Terms
- Annual membership / maintenance fee: A yearly charge to keep the account open, even if the account is not actively used.
- Annual percentage rate (APR): The cost of credit expressed as a yearly rate. For fixed-rate loans this includes points, broker fees, and other credit charges along with the basic rate of interest. For revolving credit lines these other costs are not included in the APR.
- Application fee: Fees charged when a borrower applies for credit. These fees typically include things like property appraisal or accessing a consumer's credit scores & are typically not refundable if the borrower does not use the credit.
- Balloon payment: A large lump-sum payment due at the end of a loan or lease term.
- Closing / settlement costs: Fees associated with settling on a loan. The Real Estate Settlement Procedures Act requires the borrower receive a good faith estimate within 3 days of applying for a loan. The estimate must itemize & categorize anticipated costs. These may include: application fees, title examination & survey fees, deed preparation, recording fees, attorneys' fees, notary, appraisal, & credit reporting fees.
- Credit limit: The maximum amount which may be borrowed on a line of credit.
- Home equity: The difference between the fair market value of a home and any outstanding debt on the property.
- Home equity loan: A second mortgage where the homeowner obtains a fixed lump sum of cash and pays off the loan on a regular amortization schedule.
- Home equity line of credit: A second mortgage which is a revolving credit line where a homeowner can periodically access funds and pay back the debt with great flexibility.
- Index: A reference rate at which other debt is priced against. Common indexes include prime rate, federal funds rate, U.S. Treasury bill rate, cost of funds index (COFI) & London Interbank Offer Rate (LIBOR).
- Interest rate: The cost of borrowing money stated as a percentage of the principal loan amount at an annual rate.
- Interest rate cap: Limit on the rate of interest which can be charged on a loan or line of credit. Various states have different limits. For instance, the California limit is 18%.
- Introductory interest rate: Some lenders offer a below-market rate to encourage borrowers to use their home equity lines. These offers typically last anywhere from 6 months to a year before the rates reset to an ordinary interest rate. This rate is also often called a teaser rate.
- Margin: An amount added to the index to compensate lenders for credit risk.
- Minimum payment: The lowest monthly payment which the lender considers reasonable to keep your account in good standing. In some cases this may cover interest, while other cases require it cover interest & principal repayment.
- Points: An upfront fee lenders charge on both fixed-rate & adjustable-rate loans to cover loan origination costs (origination points) or to compensate the lender or broker for offering a more competitive interest rate (discount points). Points can be paid by a home buyer, home seller, or split between them. If points are rolled into the loan they increase the loan's principal and total borrowing cost. Points equate to 1% of the principal value of a loan. 1 point on a $50,000 second mortgage would cost $500.
- Security interest: Credit agreements may state a creditor's explicit legal right to property used as collateral to guarantee your payment obligation.
- Transaction fee: A fee which is charged each time a cash advance, balance transfer, withdrawal or other similar transaction is used on a line of credit.
- Variable rate: An interest rate which periodically changes based on the changes in a referenced index rate. As rates change so do the associated interest charges & thus loan payments.
Use Your Resources
In addition to shopping lenders to find your best HELOC offers, you will be well served to look into the other options you might have, such as government programs. The CFPB offers a free guide to understanding HELOCs & the Department of Housing and Urban Development (HUD) offers free counseling services to help each consumer understand and find their best options.
It may be very tempting to leverage the equity you've earned in your home, but you should do so wisely. If you are careful in selecting the loan product that fits your situation and needs, you can typically use equity very strategically and comfortably.
Some of the risk of a HELOC is that it is easy to use and spending more than you “should” during the draw period is a very real possibility. However, if you plan for the “shock” of the increased payments of the repayment period and spend with caution and forethought, you can join the thousands of homeowners who find HELOCs to be a great way to leverage financial growth and stability.
If you have any questions you can email us today at heloc@heloc.net.
