Home Equity Line Of Credit (HELOC)
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A home equity line of credit, HELOC in short, is a credit line secured by property.
Because it is a secured credit facility as opposed to an unsecured one, it has a lower interest rate compared to typical credit lines.
The limit set on the account depends on the applicant’s request and subject to LTV.
For example, if a property is worth $750,000 with $300,000 loan balance. At a LTV of let’s say 50%, the maximum loan will amount to $375,000. After deducting the loan balance, we would be left with $75,000. This would be the credit limit on the HELOC.
In layman language, a HELOC is basically a big overdraft account secured by your home.
Because lender’s don’t profit from interest unless the borrower uses the facility, they tend to charge an annual fee to maintain the account.
Compare this to a regular home equity loan where the lender immediately charges an interest on funds when the loan is disbursed.
Because of this predictable lack of usage causing lack of interest charges, lenders make up for it by charging a higher interest rate compared to regular mortgages.
In fact, the interest rates on HELOC are at least twice that of regular home loans… and some are ten times that of home loans.
The silver lining is that people who sign up for HELOCs are usually more prudent with money and spendings. Otherwise they would have gone with a lump sum term loan instead.
The line of credit is usually used as a source of emergency funds should it be required in future.
This is also why a lot of borrowers don’t actually use the facility and keep it as a source of peace of mind.
How interest is calculated
Because of how active an account could be with daily deposits and withdrawals, interest rates on credit lines are calculated on a daily basis.
For example, a facility with a 6% annual interest would have a 0.50% monthly interest and a 0.016% daily interest.
If the daily average balance is $10,000 during a 30-day month, the total interest incurred would be $48 ($10,000 x 0.016% x 30).
If the account calculated interest costs on a monthly basis then the interest cost would be $50 ($10,000 x 0.50%).
However, do note that even though HELOCs can be inexpensive, especially when you don’t use it a lot, it is also a loan against property.
Meaning that if you were to default on it, lenders can still legally foreclose the house.
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