What You Need to Know When Shopping for a HELOC
A Home Equity Line of Credit (HELOC) is essentially a revolving line of credit with a set limit that is secured by the equity in your house.
A HELOC can be a great way to access relatively low-cost funds that could be used to purchase a new property, fix up a property that you already own, as well as countless other uses. One of the advantages of a HELOC over a traditional mortgage is that the cost to open a HELOC is usually much less - possibly even free. Additionally, because a HELOC is a line of credit, you only have to pay interest when you actually use it (similar to how a credit card works). Also, as an added bonus, the interest you do end up paying on a HELOC may even be tax-deductible (consult your own tax advisor regarding interest deductibility).
Calling around to different banks and/or credit unions can be a good place to start looking for a HELOC that will work for your particular situation. But often times, people don’t even know what questions to ask once they start calling around. After all, there are no Fannie Mae/Freddie Mac rules or guidelines for HELOCs like there are for traditional mortgages because HELOCs are just a product of the individual banks that offer them. So the rules and terms pertaining to HELOCs can vary quite a bit from lender to lender.
Below you will find a list of questions that I put together to help guide you as you call around to different lenders and try to determine which one will be the best fit for you:
~ Do you offer HELOCs on investment properties, or only on owner-occupied properties? (Most banks will only offer HELOCs on owner-occupied properties, but some will also offer them on investment properties. Remember, every bank sets their own criteria, so just because one bank tells you that they don’t do it, doesn’t mean that it can’t be done.)
~ Is there a limit on how many financed properties the borrower can have? (Some lenders may have a limit of something like 4 properties, other lenders will not have any limit at all.)
~ What is the maximum Loan-To-Value (LTV) for your HELOCs? (Expect a lower LTV on an investment property vs an owner-occupied property. Also, keep in mind that whatever LTV they quote you is the maximum they will do. It can be lower if you have a low credit score or a high DTI ratio.)
~ Do you require an appraisal to determine the property’s value? If so, who pays for the appraisal? (Some banks will pay for the appraisal and some will charge you for the appraisal.)
~ Are there any initial or ongoing costs associated with opening a HELOC? If so, what are they? (An example of an initial cost would be an application fee. An example of an ongoing cost would be an annual fee.)
~ Is there a fee for closing the HELOC before a certain time? (Since HELOCs have such low, and sometimes no, upfront costs to open them, it’s common for banks to charge an early close fee if you completely close the HELOC in the first three years to help offset the costs they’ve incurred. An easy way to avoid this fee is to just not close the account. You can just leave it open with a zero balance and you’ll avoid the fee.)
~ What is the interest rate charged? (Most banks use a variable interest rate that is usually based on the Prime Rate + a margin. You can look up the Prime Rate online. At the time of this writing, it is currently 3.5%. The margin is an additional percentage added to the Prime Rate to get your total interest rate. So if the bank tells you their interest rate is Prime + 2, then you would take the Prime Rate of 3.5% and add 2% to that to determine that your total interest rate will be 5.5%. Keep in mind though, since the HELOC is a variable interest rate product, that if the Prime Rate goes up – so will your total interest rate. The Prime Rate has historically been fairly stable. It’s been under 4% since December 2008. However, if the variable rate is a big concern for you, then you could ask the bank if they offer the option to do a fixed-rate draw on the HELOC. Some banks will give you this option in exchange for charging a slightly higher guaranteed interest rate.)
~ Is there any way to get a discount on the interest rate? (Some banks will give you a small discount for opening up a new account with the bank or having your monthly HELOC payment auto withdrawn from a checking account. The discount will likely be small, like a quarter of a percent up to a half of a percent, but it doesn’t hurt to ask.)
~ Is there a cap on the interest rate that can be charged? If so, what is it?
~ Are there any restrictions on what the money can be used for? (Most banks are going to have some restrictions on what the money can NOT be used for. For instance, I've had banks tell me the funds cannot be used for things like "business purposes", "educational uses", and "new property purchases". Since each bank can make up their own rules, there's no way to know what a particular bank will or won’t allow unless you ask them. And I'd suggest asking them before you even apply so you don't find out too late that you intended to use the money for a purpose they don’t permit.)
~ How long does it typically take from the time you apply for the HELOC to the time when it is approved and available for use? (If you need the money right away and time is of the essence, the bank’s ability to get the HELOC approved quickly could be an important factor.)
~ How long is the draw period? What happens after that term expires? If there's still a balance at that time, what are the repayment terms? Is there an option to convert any outstanding balance to a fixed term loan? Can the draw period be extended? (10 years is a common initial draw period for HELOCs. After that time, the bank may let you apply for an extension – like for another 10 year draw period where you could continue to use the HELOC while you repay it. Or, they may offer you the option to convert the outstanding balance to a fixed term loan, possibly up to 15 or 20 years, during which time you must pay off the balance but can no longer draw on the HELOC.)
~ How are monthly payments on the balance calculated? (Unlike a traditional fixed term mortgage, the monthly payments on a HELOC could vary based on the amount withdrawn and total outstanding balance. Also, some lenders may require monthly principal and interest payments, while others require interest only payments. You’ll want to have an idea of what your monthly payments will be though so you can budget for it.)
~ What are the options for withdrawing/using the money from the HELOC? Can you withdraw actual cash? Do you get a checkbook? ATM card? Cashier's checks? (It might make a difference for you depending on who you need to pay or how you intend to use the HELOC.)
~ Is there a minimum amount that can be withdrawn at a time? (I have seen minimum advances be as low as $300 and as high as $4,000 so it’s important to find out to make sure it’ll work for you.)
~ Lastly, if everything sounds good and you decide to move forward, how do you apply for a HELOC and what documents will be required (i.e. paystubs, tax returns, bank statements, copy of property insurance, schedule of real estate, etc).
Knowing the answers to all of these questions will make you a much more informed consumer and allow you to pick the lender, and the HELOC, that is right for you!