Questions to ask before you apply for a home equity loan

Different lenders offer different terms on a home equity line of credit (HELOC). The following are some questions you should ask before you apply for a HELOC.

How much can I borrow on a HELOC?

Lenders can use differing formulas to calculate how much you can borrow against your home’s equity. Those formulas will take into account factors like your creditworthiness, your outstanding debt, your ability to repay the loan, the appraised value of your home and the loan-to-value ratio (LTV).

What is my loan-to-value (LTV)?

Your LTV is the relationship between your current outstanding balance on your mortgage loan and your home’s value. The LTV enables the lender to determine how much you are able to borrow based on the value of your home. Your home’s equity can be determined by finding the difference between the fair market value of your property and the outstanding balance of all liens associated with the subject property.

LTV calculation example

To calculate your loan-to-value ratio, divide the balance you owe on your first mortgage by the value of your home.

In the following example, our home owner owes $150,000 on a home worth $200,000.

$150,000 (first mortgage balance) / $200,000 (property value) = 75% (current LTV)

Do I need income to qualify?

Although the home equity line of credit is a lien against your property, you still must have sufficient income to qualify for the loan. Income is used to establish the repayment of the loan through monthly payments. The collateral (home) alone does not repay the monthly payments. Lenders may vary when establishing income requirements.

What are the upfront closing costs?

When you take out a HELOC, there may be closing costs associated with your request. These can include a title search, appraisal or property valuation document, recording fees and other miscellaneous fees. Not every lender requires all of these expenses, so be sure to ask about closing costs before you commit to the loan. In some instances the lender will pay the closing costs – this is typically based on the amount of the loan borrowed. In addition to the possible closing costs, most HELOCs have an annual fee. This fee is usually charged on the one-year anniversary of the loan, and it continues annually as long as the line of credit is open for draws advances. It is usually waived for the first year.

What is the interest rate?

Ask about the type of interest rates available for the HELOC. Most HELOCs have variable interest rates which will fluctuate as the markets rise and fall. Ask if your HELOC has a periodic cap or a lifetime cap. A “cap” is a limit to how high the interest rate can rise during any given period, or over the life of the loan.

Typically the interest rate on a HELOC is tied to an index, like the prime rate. When the index rises or falls, so does the interest rate on your HELOC. Find out which index your lender uses, and how much and how often the interest rate can change. Ask about the margin – the amount added to the index that determines the interest rate you will be charged.

Finally, ask if your HELOC has an introductory rate. Sometimes lenders will offer a low introductory rate to keep minimum payments down, at least initially. Ask what happens when the introductory period is over, and your rate (and payment) increases to the true market level. Find out how your rate will be determined at the end of the discount period and how much more your payments could be at that time.

What are the repayment terms during the loan?

Does your minimum monthly payment cover both principal and interest, or interest only? Most HELOCS have a required monthly interest-only payment. However, typically you are allowed to make extra payments towards the principal. The interest-only payments are usually allowed during the draw period with principal and interest required payments during the repayment period.

Most HELOCS have a draw period, a period of time during which you can take advances on the available funds in your account; and a repayment period, the period during which any remaining balance due is amortized for a fixed term to pay the balance in full by the end of the term. Find out how long these periods are, and what happens once the draw period is over. And ask the lender if there is a minimum withdrawal requirement after your account is opened.

Knowing the answers to these questions will help you evaluate the terms of the HELOC so that you can move forward with confidence.

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