As previously published on In Business Wisconsin May 21, 2014 issue
By Rick Bondowski, senior vice president, director of customer solutions for Associated Bank
In 2013, economic indicators such as household wealth, real estate values, and home equity continued to improve compared to previous years. Buoyed by these positive trends and increased consumer confidence, home equity lines of credit (HELOC) are regaining popularity as a funding means for home improvements, educational expenses, debt consolidation, and major purchases.
A HELOC is a revolving line of credit secured by the equity you have in your home. Most lenders will make loans up to a certain percentage of your home’s value, after including other loans such as your first mortgage. This concept is referred to as a combined loan-to-value (CLTV) ratio. Assuming an 80% maximum CLTV, it works like this: If your home is valued at $200,000, 80% of that is $160,000. That amount, minus what you still owe on the home — say, $120,000 — leaves you a possible credit line of $40,000. Keep in mind that lenders will also consider your ability to repay the loan by evaluating your income, existing debt, credit history, and other factors before determining how much they are willing to lend.
The more equity you have in your home (based on collateral value), the more credit you’ll qualify for, with HELOCs typically ranging in size from $5,000 to $250,000.
One reason many homeowners choose HELOCs is that they offer a great deal of flexibility. Since the HELOC is a line of credit, you can borrow as much or as little as your line allows. The HELOC may also be used for multiple purposes, so there’s no need to apply for a new loan each time you need to borrow. Also, since it’s a revolving line of credit, you can borrow, pay down balances, and reuse your available credit over and over again.
However, when considering whether a HELOC is right for you, you need to keep a number of things in mind. First, make sure you shop for credit terms that best meet your borrowing needs without putting you at financial risk. Keep in mind that interest rates on HELOCs are generally variable and may change frequently during the life of your loan. Typically the interest rate you pay is comprised of the prime rate plus a margin that takes into account your CLTV, as well as credit factors such as your income, debts, and credit history.
If you are uncomfortable with variable rates, many lenders provide the opportunity to lock in some or all of your outstanding balances into a fixed-rate, fixed-payment loan, within your HELOC. This feature also enables you to pay off your balances on a specific timetable, with payments consisting of interest and principal.
Some HELOCs have attractive introductory rates, but those rates can increase at a future date, leaving consumers with increased payments once the rates reset.
One of the most important considerations is to determine how you will repay your loan. While a HELOC may require interest-only payments, borrowers are increasingly opting to pay more than the minimum, and lenders are taking note. Some plans set a minimum monthly payment that includes a portion of the principal plus accrued interested. Some borrowers will choose to pay enough monthly principal to ensure the loan is paid off at the end of the term.
Consumers should also inquire about closing costs, miscellaneous costs for applications and appraisals, and the draw period. The draw period refers to the set time frame in which one can draw from an established line of credit. Consumers also need to ask whether the HELOC debt is convertible in the future to a fully amortized, fixed-rate loan.
As with any loan, before signing the paperwork, it’s important to understand the risks, fees, and payment plans to ensure that this decision will be a good one. As consumers explore the attractive options of a HELOC, they should be sure to find a compatible banker who will work with them to answer all their questions and to make sure they are comfortable and confident with their decision.