When it comes to a home equity line of credit and putting it to work to improve your financial situation, you probably have a lot of questions. And that’s a good thing! Before you make any big decisions, there are a few things you need to know. Check out our list of top questions to ask any loan officer about HELOC terms.
1. How is your interest rate built?
You may have heard that the interest rate associated with a HELOC is less important than the rate on your traditional mortgage. But it’s essential to understand how your rate is built and its limits. Most banks use a term called “variable interest rate,” meaning the interest rate varies over time. But how much does it vary and how often?
It’s worth noting that most HELOCs are built on a simple combination of Margin + Index. The Margin is the rate at which a bank prices a loan on a base level, but it’s isn’t your actual start rate. It’s the minimum interest the bank can afford to charge a borrower for lending a minimum dollar amount to them. This rate is fixed and is typically based on qualifying factors like credit score, loan to value, occupancy and loan amount.
Index is the variable rate that’s added to your margin. This is the adjustable part of the combination and is based on the index the bank uses. This index can adjust monthly, quarterly, semi-yearly or at other times based on economic factors. One well-known index is LIBOR (considered by some to be better than Prime, another common index). A quick Google search will reveal the historical ups and downs of the rate – giving you a better picture of its long-term stability.
If you’d like to learn more about interest rates and how they apply to HELOC qualification, download our eBook here.
2. What is the actual term of the loan?
Not all HELOCs have the same interest-only term for their loan. Some are advertised as a 15-year HELOC but offer the interest-only term for 5 years, followed by 10 years of amortized payments (meaning you have 10 years to pay off the balance of the loan). Look for a HELOC with a full 10-year interest-only period, followed by a repayment period. In addition, we strongly recommend consumers avoid HELOCs with a 10-year term followed by a balloon payment (payment due in full) at the end. This can be a risky financial move for most people.
3. Do you have a pre-payment penalty?
HELOCs can be subject to a pre-payment penalty on a state-by-state basis. There should be no hesitancy by your lender to share these terms with you. By law, some states do not allow pre-payment penalties of any kind. As an example, our preferred lender charges a prepayment penalty if the loan is paid off within the first 36 months. The penalty is based on 2 percent of the outstanding balance. Most people will not pay off their HELOC in this timeframe, but it may be required if a job change or other unexpected scenario makes selling your home a necessity.
Depending on where your property is located, the penalty for paying off your loan early may be based on your outstanding balance at the time of the final payment or the initial line amount for the loan. If applicable, this penalty is typically 1 to 3 percent.
4. Do you offer direct deposit to the HELOC?
Traditional HELOCs are a very manual process. When your paycheck is deposited to your cash account, then money must be transferred to pay down the HELOC balance. There’s a higher possibility of human error with this approach, in addition to delays in posting times – which costs you money in interest savings. What’s more, some HELOCs also use a sweep account to transfer money into the account. Not bad, but not great. There aren’t many banks that offer direct deposit, even though it’s the one feature that keeps you in control of your money at all times.
Instead of being deposited into a sweep account where it’s transferred at the close of the business that day, a direct deposit HELOC acts as your house bank account. With a sweep account, you lose at least 1 business day of lower interest every month as a result of that lag time before your money hits the HELOC account. If you get paid twice a month, that’s 24 days a year where you’ll be paying a higher interest rate than you should. And if you’re occasionally forgetful about moving money, you’ll also risk paying higher than optimal interest. Having direct deposit to the HELOC takes out the guesswork and delays and puts more of your money to work for you.
Any other questions to ask your loan officer about HELOC terms?