A HELOC works differently than your standard mortgage. Yes, you still put your home up as collateral, but there are many other aspects to this loan program. There are certain questions you should ask of the lender in order to determine if the loan is right for you. No two lenders will have the same parameters either. If you plan to shop around, make sure to ask detailed questions so you know exactly what you are getting yourself into with your chosen HELOC lender.
What is the Maximum LTV you Allow?
Every lender has different HELOC programs – they are not the same across the board. Depending on your use of the funds from your HELOC, you may need to find a lender that offers a high LTV loan. This should be one of the first questions you ask before you even apply for a HELOC. If you have a general idea of the value of your home and you know the outstanding amount of principal on your first loan, you can determine your current LTV. For example, if your home is worth $300,000 and your current 1st mortgage has a balance of $200,000, your LTV equals 66.7%. If you find a lender that allows up to an 80% CLTV, you could borrow $40,000 in a HELOC.
How Long is the Teaser Rate?
Most HELOCs have a teaser or introductory rate. This is the rate you pay initially, but after the teaser period ends, the rate adjusts. Generally, the lower the teaser rate, the shorter the period it is offered. This is how lenders get you into their bank and convince you to take their loan. You see this attractive rate and you take out the funds you need. However, what they don’t tell you is the rate will increase after a specific period of time. It pays to know how long that period lasts so that you can figure out how much you can afford when the payments potentially increase.
How Will the Rate Adjust?
Once you know the introductory rate period, you need to know when the rate will adjust and what will adjust to. Most HELOC rates are based on prime plus the designated margin. The margin used is what you need to know. This way you can watch it and predict how your rate will be affected in the long run. There is no way to predict if the rate will increase or decrease and by how much. However, knowing the margin can help you look at its past history to determine if you want to take a chance with this loan. Knowing how often the rate can adjust also helps as it allows you to plan ahead for a possible higher interest rate.
Are There Minimum Requirements?
Some lenders are very particular about the amount of money you draw and/or keep in your account. If you don’t follow their rules, you could end up with a serious penalty as a result. Ask the HELOC lender about any minimums as well as the consequence if you do not meet those minimums. It would be a rather unpleasant surprise to find out you have to pay hundreds of dollars in fees because you did not read the fine print on your closing documents.
What Happens After the Draw Period?
Every lender sets their own draw period. Typically, it is for 10 years, but they may differ. Ask the lender how long you are able to draw funds out from the HELOC as well as what happens when the draw period ends. Do you receive a fixed interest rate when the draw period ends? If so, what is the rate? You should also ask if there is any type of balloon payment that becomes due at any point during the repayment period. Some loans become immediately due after the draw period ends. This could obviously leave you in a serious financial bind if you do not realize it ahead of time. Make sure you fully understand the repayment terms ahead of time.
What Closing Costs Does the HELOC Lender Charge?
Typically, a HELOC lender does not charge closing costs as high as you paid for your first mortgage. There is not as much work involved in the HELOC, so the costs are minimal. It pays to know what each lender charges, though. If you shopped around with your first mortgage, you understand the importance of figuring out the best deal available. You should look at the closing costs as well as the interest rates to help you make the right decision.
Is There a Cancellation Fee?
Some HELOC lenders charge a cancellation fee if you pay your loan off too early. They rely on making interest on your loan for at least the draw period, but typically beyond. This is how they make their profit. If you suddenly pay the line off, the lender loses out on the interest. In order to make up for the loss, they may charge a prepayment penalty. These are fewer and further between in today’s market, but it is always important to find out ahead of time.
Finding the right HELOC lender works a little different from when you searched for the lender for your first mortgage. There are different questions to ask and different scenarios to consider. Just as was the case with your first mortgage, you should apply with at least three lenders to see what they have to offer. Each lender may have a different program along with different charges. If you want to find the program that fits you the best, compare the APR to see how much the loan will cost you over the life of the loan. You may also want to base your decision on the ability to prepay or cancel the loan and/or the outcome of the interest rate during the repayment period.
There are many factors to consider with a HELOC and HELOC lender. Take your time and do your research to find the one that is right for you.
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