Last Updated on December 11, 2019
A HELOC, otherwise known as a home equity line of credit, isn’t the same as an equity loan. Consumers set up the accounts after building up equity in their home.
The products are similar to a store account where the consumer has access to a line of credit with a defined value. The borrower accesses the funds whenever they choose and remove the value they want up to the limit. The lenders don’t control what the money is used for or how often the consumer accesses their money during the draw period.
Let’s discuss the credit lines and how they work to understand fully what consumers are facing.
How Does HELOC Work
How are Consumers Approved?
The lender reviews three vital attributes for approving the borrower. The loan-to-value ratio, income-to-debt ratio, and the credit score are these attributes. For approval, the loan-to-value ratio is 15 percent, the income-to-debt ratio is 43 percent, and the credit score is 620.
The loan-to-value ratio determines how much equity the borrower accumulated. The income-to-debt ratio establishes affordability of the credit line, and the credit score defines the consumer’s creditworthiness.
Interest Rate Considerations
Consumers set up the credit line to pay off existing debts that have a higher than average interest rate. This is beneficial for consumers who obtain a lower interest rate and pay off the debt quickly.
However, consumers don’t understand that the credit line has a variable rate and won’t stay at the exact value throughout the contract. For this reason, the balance increases according to the current interest rates and aren’t fixed.
What is the Draw Period?
Essentially, the draw period is the duration in which the consumer has to use the credit line. The minimum draw period is 5 years, and the maximum is 10 years. Once the draw period ends, the consumer no longer has access to the remaining balance, and the repayment period starts.
Payment and Replenishment
Each time the consumer uses the credit line and pays back what they owe, the total accessible funds increase. However, the consumer has to do this during the draw period. As long as they pay what they owe they maximize the overall value.
Using the strategy helps the consumer maximize their credit line and continue to borrow more proceeds before the interest rate applies fully.
What is the Repayment Period?
After the draw period ends, the consumer enters the repayment period. They have between ten and twenty years to pay the balance off. The current interest rate applies to the total balance at the beginning of the repayment period.
Again, the interest rate won’t remain the same throughout the entire contract. The borrower reviews the interest rate when choosing how long to take to repay the credit line. Having a plan helps them avoid excessive interest costs and control their expenses.
Why Get a HELOC
The lenders don’t restrict how the consumer uses their credit line. Consumers use the money to contribute to college funds, purchase more real estate to make money on the side, renovate existing properties, and consolidate certain debts.
The consumers can use the money for generating an emergency fund or even purchase a car. Reviewing the total value of their credit line helps them make sound choices about how to use it.