If you are a homeowner, you’ve probably received offers to apply for a home-equity line of credit (HELOC) loan. Handled with care, HELOC loans can be an excellent way to improve financial flexibility, provide readily available cash reserves for emergencies, or pay for large expenses (like college tuition or home improvements) that have irregular payment schedules. But be aware that not all home-equity credit lines are created equal. If you decide that a HELOC is right for you, what features should you look for? Here are ten things that should be at the top of your list:
1. No application fee (or fee should be refunded at closing – The HELOC loan market is very competitive. Some lenders may charge a fee to help cover their costs of processing your HELOC application and to ensure applications are received only from seriously interested homeowners. If your lender assesses an application fee, be certain that it is refundable at closing. Otherwise, look elsewhere for your HELOC loan.
2. No appraisal or closing costs – The market value of your property is key to determining the amount of your credit line. Some lenders are willing to use publicly available tax assessment data in lieu of formal appraisals. Others may absorb appraisal costs to attract customers. Either way, there are enough no-cost options available that you should not have to settle for HELOC lender that charges appraisal costs or any other closing costs.
3. No account maintenance or check-writing fees – Lenders obviously make their money when you write checks (borrow) on the home-equity credit line. Most lenders make it as hassle-free as possible with free checks and, sometimes, even debit cards. If your lender charges fees for the privilege of having a HELOC checking account, look elsewhere.
4. No "non-usage" fees – On the other hand, a few lenders have started assessing fees to homeowners who take out home-equity credit lines but don’t use them enough! Apparently they don’t approve of the notion that a homeowner may want to have a HELOC as an emergency “reserve” account. Definitely look for a lender that does not charge this type of fee.
5. Variable APR equal to or near the prime rate (adjusted quarterly) – The only cost involved with a good home equity credit line should be interest charged (APR) on the balance borrowed. As with any loan, the borrower’s goal is to get the lowest possible APR. Most lenders use the “prime rate” as published in the Wall Street Journal (or other publication) as a base index and charge you an APR equal to prime plus or minus a marginal percentage (e.g. 0.25%). Search for the best rate available, but be aware of low “teaser” rates that may suddenly change after a brief introductory period or be accompanied by special fees. Also, keep in mind that the periodic and lifetime caps on rate changes are as important as the initial rate (see below).
6. Periodic cap on interest rate changes (the amount that the rate can be changed at one time) – Virtually all HELOC loans are variable rate loans meaning that the initial interest rate (APR) will change at some point as surely as the weather. A key is to understand how often the rate can adjust and how much the rate can be adjusted at one time. Of course, when rates are falling the larger and faster the change, the better for you. But more important is the upside risk you face when rates are rising. Look for a HELOC that adjusts quarterly (rather than monthly) in increments of 0.5% or less. Note: with expectations of rising interest rates, many lenders appear to be eliminating the periodic rate cap feature and raising lifetime caps to legal limits. If you have an older HELOC that incorporates relatively low rate ceilings (or if you find one), consider yourself fortunate!
7. Lifetime cap on rate increases (the amount that the rate can be adjusted over the loan's life) – A good HELOC is something you’ll want to keep for awhile. Although interest rates have been at relatively low levels for a number of years, it wasn’t too long ago that a 10% loan was regarded as a bargain! The point is that interest rates over time can rise dramatically. You’ll want to find a HELOC with a lifetime rate cap that you can live with. Ask your loan officer to clearly spell out the “worst case” scenario for rate increases for the HELOC you are applying for.
8. Ability to convert to a fixed rate loan – When rates do rise, people often get skittish about their variable-rate debt. A useful feature to look for in a HELOC is the ability to convert the line of credit to a standard fixed-rate, fixed-term home-equity loan (HEL). You likely won’t get an APR as favorable as a newly issued HEL, but you also won’t have appraisal or closing costs to pay if you convert. However, note that many lenders charge a fee for converting to a fixed rate loan.
9. Interest-only payments allowed – It is usually best to make regular principal payments on your HELOC balance. Yet a job loss or other emergency can make it a challenge to keep payments current. In these situations it is nice to have the flexibility to lower your HELOC payment as much as possible without increasing your loan balance or raising red flags at the credit rating agencies.
10. Unrestricted ability to repay principal without penalty – On the other hand, you also want the flexibility to pay down principal on the loan when you choose. You may get a bonus from your job that you want to apply to the loan or you may find a 0% balance transfer offer that is worth taking advantage of. In any case, a key component of a good HELOC is the unfettered ability to repay principal.
Shop around and you will be able to find a HELOC loan with many (if not all) of these features. Keep in mind that your bank is not the only game in town. Credit card companies, mortgage bankers and brokerage firms have all entered the market and offer competing products. Credit unions typically offer excellent terms and should not be overlooked. Also, there are many reputable on-line sources that have lower overhead costs and may be able to offer better terms than the local bank.
