Home Equity Credit Lines

  
     

What is a Home Equity Credit Line?
A home equity credit line is a variable rate second mortgage that uses the equity in your home as security for the loan. The interest rate follows the movements of an index, in most cases the prime rate. A margin or markup is then added to the index to arrive at the adjusted rate. Monthly payments increase or decrease based upon changes in the index. 


How Does it Work?
Unlike traditional second mortgages, where the entire loan amount is given in one lump sum, approved homeowners are given access to a revolving line of credit which may be drawn upon by check, or in some cases, a credit card. Interest is paid only on the borrowed funds.


Loan Description
Variations among home equity credit lines allow you to choose the product that best fits your needs. The following is a clear description of the terms of these loans, and the choices available to borrowers.


Qualified Property: Generally, anyone who owns and occupies a one to four family home or condominium may qualify for a home equity credit line. Some lenders offer the loan to owners of cooperatives, with certain restrictions. Also, some lenders do not require that the home be owner-occupied to qualify.

Annual Percentage Rate (APR):
The APR is the cost of credit on a yearly basis. It includes the interest rate, points, mortgage broker fees, and other charges that are required. The average APR is usually about 8.75%.

Index: The index is the economic indicator for the loan and may increase or decrease reflecting market conditions. While most home equity credit lines use the prime rate as the index, lenders may also use three-month treasury bills or other indexes. The prime rate is the rate major lending institutions offer their most creditworthy clients. The prime rate is listed in a variety of publications, e.g., The Wall Street Journal, The New York Times, and the Federal Reserve Statistical Release.

Margin: The percentage added to the index to arrive at the adjusted rate. It varies among lenders, generally ranging from 1% to 3%. Some lenders offer a discounted margin for their customers.

Interest Rate Adjustments: The frequency with which the interest rate is adjusted, based on changes in the index varies among lenders. Common interest rate adjustment periods include: daily, weekly, bi-weekly, monthly and quarterly.

Caps:
A cap is the highest an adjusted rate (index plus margin) can go over the life of a loan. If the lender does not offer a cap, then the rate may increase to the limit set by law, which is currently 25% in New York State.

Loan Term: The loan term is the duration of the loan. With home equity credit lines, borrowers may generally choose a loan term as short as five years or as long as 40 years.

Access Period: The access period is the time during which funds may be accessed. Some lenders allow borrowers to access funds for five years while others allow borrowers to draw funds throughout the duration of the loan.

Payment Options: There are a variety of payment plans available to borrowers. Generally, lenders offer borrowers the option of paying interest only for a set period of time, followed by payments of interest plus principal for the remainder of the loan term. The interest only period may range from approximately five to 40 years. However, borrowers may choose to pay principal for the entire loan term.


Maximum Credit Line Worksheet
This worksheet can help you approximate your credit line. Remember that a lender will also use your current income as a large factor in determining loans. 

The lender's appraised value of the home:

The lender's appraised value of the home:

$ ___________

Multiply by the maximum percent of equity allowed by the lender (usually between 60% and 75%):

X ___________

Minus current balance of first mortgage or other liens:

- ____________

Your approximate maximum credit line:

_____________


Another option offered by some lenders is a balloon payment plan, where funds may be accessed and interest paid for a set period of time, usually five to ten years. After that time, the entire balance is due and payable.

Maximum Loan:
The maximum loan is usually determined by using a percentage, generally up to 60% or 75%, of the appraised value of the home, minus the remaining first mortgage or other lien outstanding. You can use the worksheet above to calculate the approximate maximum loan available to you. Another factor lenders may use in determining the maximum loan amount is your income.

Minimum Monthly Payment: Some lenders may require a minimum dollar amount monthly payment, usually ranging from $50 to $200.

Minimum Withdrawal:
Most lenders require a minimum amount per withdrawal, ranging from $500 to $1,000.

Credit Evaluation Clause:
Some lenders include in the loan agreement a provision allowing the lender to close the credit line or lower the credit limit if they determine that your creditworthiness has changed and does not satisfy customary credit standards as then applied by the lender.

Fees And Related Costs: If a lender charges an application or processing fee, it usually ranges from $175 to $490. However, in some cases, this fee is applied to closing costs. The amount of closing costs may be substantial and vary from lender to lender. They will usually include some or all of the following: attorney's fee, mortgage recording fee, mortgage tax, title insurance, title search, survey update fee, variable rate mortgage endorsement fee, and an appraisal fee.


Costs Versus Fees Worksheet

Fees and Costs

Lender 1

Lender 2

Lender 3

Attorney's Fee

$__________

$__________

$__________

Mortgage Recording Fee

__________

__________

__________

Mortgage Tax

__________

__________

__________

Title Insurance

__________

__________

__________

Title Search

__________

__________

__________

Survey Update Fee

__________

__________

__________

Variable Rate Mortgage Endorsement Fee

__________

__________

__________

Appraisal Fee

__________

__________

__________

Application/Processing Fee

__________

__________

__________

Tax Search Fee

__________

__________

__________

Flood Search Fee

__________

__________

__________

Credit Check Fee

__________

__________

__________

UCC Search/Filing Fee

__________

__________

__________

Total

$_________

$_________

$_________



Items to Consider
Home equity credit lines afford easy access to the equity in your home. However, you may wish to give serious thought to the following items when considering this type of loan.

1. Since most lenders presently do not offer caps on these loans, you do not know how much the rate may increase or decrease over the term of the loan. Therefore, make sure you consider the affordability of payments if rates should increase.

2. While many lenders do not charge points, make sure you factor in the amount of closing and other costs.

3. While many lenders offer low introductory rates, keep in mind the duration of the special rate as compared to the long-term rate.

4. If you pay interest only for a period of time, make sure your income is sufficient to cover the increased monthly payments that may occur when you repay the principal.

5. While interest payments may be tax-deductible, it is important to consult a qualified accountant or tax specialist to determine deductibility.

6. Consider carefully how you will use the loan funds. Many experts warn the increase in buying power may cause you to become overextended.


Canceling a Loan
The Truth in Lending Act gives you three days to cancel your loan in writing. In some cases this period might be longer. It is therefore important to consult with your attorney before canceling anything. The lender then has 20 days to return all of the money or property you paid and release any security interest in your home.