What does a HELOC entail?

In a HELOC, the value of a house provides the collateral for a line of credit. The lines of credit generally have fixed terms, and derive their value from a formulation of a specified percentage of a home's appraised value minus the balance still outstanding on the mortgage. Every lender and particular HELOC offering is different, so the Consumer Financial Protection Bureau (CFPB) recommends shopping around and looking for a loan that fits a particular borrower's needs.

The government agency noted that when setting up a HELOC, homeowners typically have to pay an appraisal fee, application fee and potentially a percentage point of the credit limit up front. As with normal mortgages, there are closing costs associated with paying the attorneys and other professionals handling the case. There are also fees such as membership or maintenance charges, as well as potential transactional fees.

In some HELOCs, borrowers can make payments that only count toward interest, rather than the principal borrowed. In those cases, the principal will be due at the end of the payment plan. In other cases, the repayment plan does anticipate paying off the balance of the loan. Some HELOCs have variable interest rates, which can fluctuate from month to month.

Selling a home tends to mean paying off any HELOCs drawn on equity in that property right away. Homeowners who are planning to move on from a current home therefore have less incentive to take out a line of credit than those who are settling down for a long time to come.

HELOC on a Second Home: What You Need to Know

One use of a HELOC involves taking out another loan during the homebuying or refinancing process to make a high-value home more affordable. The second loan, using a high percentage of the home's value as collateral, offsets the costs of the house, and may represent a way to manage lower payments overall, removing the need for extra mortgage insurance.

Flexible monthly repayment schedules enable borrowers to pay off the loan in a way that makes sense for their unique circumstances. Extra principal payments can go towards paying the HELOC balance and lowering overall payments.

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SOURCE

CFPB