Credit Lines
A home equity line of credit (HELOC) is one type of credit line. A HELOC is a revolving line of credit secured against a piece of real estate that let's you borrow again and again. Unlike credit cards and auto loans, interest on a HELOC is not compounded meaning, any reduction in the principal pays down the loan much faster than a compound interest loan. Because payments on a HELOC are generally tax deductable and significantly lower than that of unsecured credit lines, HELOCs are popular ways of financing a new car, home improvements, consolidating debt, or some other large purchase.
Avoid PMI with a HELOC
A HELOC can be used to avoid private mortgage insurance (PMI) when less cash is on-hand than required for a downpayment.
When a HELOC is used to avoid PMI, the full amount will generally be drawn on and you will not receive an initial checkbook. Later, once you begin paying down the HELOC, you will receive a checkbook.
A few scenarios where a HELOC can be used to avoid PMI are:
- You don't have cash for a downpayment but have equity in other real estate. A HELOC can be opened on the other real estate in the amount needed for the downpayment. There will be one closing for the property the HELOC is opened on and a second closing for the property that is being purchased. The property being purchased will not be linked to the property the HELOC was taken out on. Meaning, the two will appear as separate mortgages on separate property.
- You don't have cash for downpayment and do not have equity in other real estate. In this case, two mortgages will be written for the property being purchased. One mortgage for the HELOC and a separate first mortgage. The HELOC will be a second mortgage subordinate to the first mortgage.
Payment Calculation
Interest on a HELOC is simple interest meaning, there is no compounding nor amortization. If you have a $50,000 HELOC fully paid down (meaning the full $50,000 is available) and you just drew $25,000 from it for a car purchase, you now owe $25,000. How much will your payment be? You will receive a statement notifying you of the amount needed but it's easy to calculate yourself. Let's assume the interest rate is presently 6%. The interest rate can go up or down from month to month but for example, let's assume your next months payment will be based on a 6% interest rate.
Your next payment will be calculated as follows:
Next Payment = where i = interest rate, b = unpaid balance, 12 = months in year. Plugging in numbers gets us Next Payment = = = $125.
The $125 is just interest which is all you have to pay. However, if you want to pay down the principal, you will need to pay an amount greater than $125. For the first payment, let's assume you only pay the $125 minimum. Your unpaid balance is still $25,000.
Second Payment
You decide to start paying an amount above the minimum in order to pay down the loan. When you opened your monthly statement, you were pleased to see the interest rate decreased to 5.875%. Using our equation we get,
Next Payment = = = = $122.40.
If you pay an additional $150 towards principal. Your payment check will be for $272.40
Third Payment
Your unpaid balance on the HELOC is now $25,000 - $150 = $24,850. Your statement indicated the interest rate went back up to 6%. Your third payment will be:
= = = $124.25
Again, the $124.25 is just the interest which is the minimum payment due. To reduce the unpaid balance, you must pay more. Let's assume you pay an additional $200 towards lowering the balance. Your payment will be for $124.25 + $200.00 = $324.00. Your unpaid balance drops $24,850 - $200 = $24,650.
This process repeats until the unpaid balance is $0 at which point you owe nothing.
Opening a HELOC is Easy
The process of opening a HELOC is fast and inexpensive. From start to finish typically takes one to two weeks. At closing, you will be given a checkbook but there are no charges until checks start being written. Because a HELOC is revolving credit, you pay it down and draw on it like a credit card. For example, assume you take out a HELOC for $5,000 but write no checks against it. Until you write the first check, you owe nothing.
After several months, you receive a call from your auto mechanic telling you your car needs $750 in repairs. You trust your mechanic so, you authorize repairs and upon completion of repairs, write a check for $750. You have now drawn down your HELOC by $750 and may only spend another $4,250. You may begin making payments on the $750 you borrowed or, payoff the $750 and bring your HELOC back to it's original $5,000 and once again owe nothing.
Early Payoff
Because of differences in the way interest is calculated with a HELOC and traditional mortgage, A HELOC can be used to payoff a 1st mortgage significantly early. We offer a 1st mortgage HELOC similar to those popular in Europe and Australia which allow you payoff your mortgage significantly early without burdensome extra payments or, the hassles of managing a HELOC to payoff your 1st mortgage.
A home equity line of credit ( HELOC ) is not the same as a home equity loan. A HELOC is a revolving line of credit that has interest only payments. If checks are never written against the HELOC, no payments are necessary. A HELOC can be paid off and drawn on many times. A home equity loan is opened in one lump sum as a first or second mortgage with payments beginning immediately. A home equity loan is also known as a cash-out refinance.
Customers considering a HELOC for home improvements should consider our rehab loans and cash out refinance. Customers considering a HELOC for reasons other than home improvement should consider our cash out refinance.