But you may be in for a shock. Increasingly, banks are suspending consumer home equity lines of credit (HELOCs) with no notice. Homeowners who think that they have access to their home equity line of credit are suddenly cut off from an expected source of funds, and their credit rating may be affected by something that seems to be out of their control. They may even inadvertently bounce checks written against the account. What’s going on?  

Falling Home Values Trigger HELOC Pullback

What’s happening is the sinking real estate market. When you take out a home equity line of credit, your bank agrees to loan you money at some future date, even as long as ten years from the time you open your HELOC. The collateral is the equity you have in your home. As long as you faithfully make your mortgage payments and your house increases in value, it’s a good deal for you and for the bank. 

For example, let’s say that in 2002 your home was appraised at $300,000 and your equity (the part that you have paid for) was $80,000. If you have good credit, a bank would have no problem granting you a $64,000 HELOC for ten years, based on a limit of 80% loan-to-value (LTV). This means that anytime until the year 2012 you could borrow up to $64,000 from your bank, using your home as collateral. 

But now it’s 2009. You have borrowed $50,000 on your HELOC, which according to your loan agreement is perfectly appropriate. You’ve been making your mortgage payments so the outstanding principal on your mortgage is now $200,000. But the appraised value of your home has plummeted to $225,000! And you owe the bank an additional $50,000 on your HELOC! 

Now the bank is worried because you owe $275,000 and your house is appraised at $255,000. You owe more than your house is worth. Bankers don’t like this, because if you default the bank will be forced to short sell your house, and the bank will lose money. 

With house values plunging across America, banks are reviewing HELOCs and are either decreasing available credit limits or closing them altogether. To evaluate which HELOCs to suspend, banks are using a variety of measurements that include geographical areas where home values have fallen significantly and individual borrowers’ payment history and credit. 

Credit Rating Repercussions

The three major credit reporting companies (TransUnion, Equifax, and Experian) collect consumer information furnished by lenders. If a lender reports an account has been closed for a reason that is derogatory in nature, the item will appear on the consumer’s credit report. Banks may claim that HELOC closings or restrictions are not derogatory, which is true; unlike other forms of revolving credit such as credit cards, HELOCs aren’t a part of a consumer’s credit utilization ratio. A key indicator of creditworthiness, the credit utilization ratio measures the percentage of the total available credit that has been accessed by the consumer. But mistakes can happen, and consumers are advised to carefully monitor their credit records, especially if their lender has changed the terms of their HELOC or closed it completely. 

If you are concerned that your bank will restrict your HELOC, some analysts suggest that you quickly tap into it while you still can. Withdraw the maximum amount of money permitted and stash it in the bank or buy Treasury notes. You’ll have to pay it back, of course, but as long as your lender hasn’t changed the rules of the game you’re totally within your rights.

Advances taken out during this draw period may have small monthly payments in which only minimal amounts are paid toward the principle with the rest of the payment going to accrued interest, or interest only payments may be made. At the end of the draw period, many plans have balloon payments in which the monthly payments will drastically increase to cover the rest of the balance due or the entire balance may be due immediately. There are plans that offer repayment of the Home Equity Line of Credit loan over a fixed period of time after the draw period has ended.

Interest of Home Equity Lines of Credit is usually variable and tied to the Prime Lending Rate, the rate in which most major banks charge their largest and most credit worthy customers. These variable rates usually have a cap to limit how high of an interest rate can be charged and some have limits as to how low the interest rate can get. Variable rates are subject to quarterly adjustment though some plans offer a fixed interest rate. The interest paid on Home Equity Lines of Credit is only paid when the funds are used and is usually tax deductible.

Like Home Equity Loans, Home Equity Lines of Credit have fees that may be charged for taking out the loan. Some plans call for one-time; up front fees while others have annual fees. Plans that offer low monthly payments during the draw period may require a balloon payment at the end of the loan period requiring the entire remaining balance to be paid. Other fees can also apply such as appraisal fee, credit check fee, and closing costs. The Federal Truth in Lending Act protects the borrower by requiring the lender to inform the borrower of all costs and terms when the application is given.

California residence taking out a Home Equity Line of Credit have the option of whether or not to allow outside and affiliate companies to have access to their private financial information. Through the California Financial Information Privacy Act, the lender can only disclose financial information about California residences with other companies if it is mandatory in securing the loan. Any other use of the information is at the borrowers’ discretion.

That is why I decided to write an article on the basic concepts of both of these fantastic financial products.

Home Equity Loan

Home equity loans are usually referred to as second mortgages, because they are secured against the value of the house. The borrower uses the equity on his property as a collateral for the loan. So… what does equity mean? Equity is the different between the property’s market value and the remaining balance of the mortgage and any owed debts related to the property. If you have finished paying the mortgage on your home (or never applied for one), then the equity on your home is 100% of the real value. If you have already paid 40% of the home, then the equity will be worth 40% of the real value of the property.

Loans based on the equity on your home are marvellous. They are granted almost to any home owner and their terms are usually extremely favourable. Not only are the interest rates very low, but they are also deductible!

What use can the borrower give to the money? Well, that is the beauty of this type of loan. You can do anything, the world is your oyster! Whether you need to remodel your house, add rooms to it, go away on a long vacation, purchase a used or new car, or even acquire a second property, home equity loans can help you in so doing. There is no limit to what you can do, only your imagination.

Repayment plans range from 5 to 20 years, and as you might have noticed, they are somewhat shorter than the repayment plans on mortgage loans.

Home Equity Lines Of Credit

This credit is also know as an open-end home equity loan. It is also a loan based on the equity on your home, but it has one major difference: you decide how much and how often to withdraw funds. The lender sets a limit on how much can be withdrawn, but once this amount is repaid, the borrower can take out funds again, and so on.

Lines of credit based on equity are perfect for you if your monthly income is variable (as often happens with self-employed people). There is a minimum monthly payment which consists of the interest rate if you have not withdrawn any funds.

If what you are looking for is flexibility, then a line of credit will be just perfect for you. No fixed monthly payments, instant availability of funds at your best convenience, among other advantages.

Now you are fully aware of what these two equity based credit products have to offer, it is up to you to choose the one which best meets your requirements.

What is a Home Equity Line of Credit?
A home equity line of credit is a loan that uses the equity you already have in your home as collateral. The loan is secured by a lien, typically a second position lien, on your home. The second lien position (also called a second mortgage) is most common because most borrowers will already have an existing first mortgage. First or third lien position home equity loans are possible as well, but occur with less frequency.

Home equity loans can be either “closed-end” or “open-end”. The home equity line of credit is an open-end loan, while a home equity installment loan is a closed-end loan. An open-ended loan has characteristics similar to that of a credit card. A borrower has a predetermined credit limit and can withdraw funds at their own discretion using HELOC checks or a HELOC withdrawal card. A monthly payment is only required if there is an existing balance, in which case the borrower has the option to pay it off in full, or make regular monthly payments according to the loan terms. The borrower may use the funds for any purpose they choose.

Most lenders are willing to extend a line of credit worth as much as 80-90% of a home’s value, minus any outstanding mortgage amounts, to qualified consumers. This calculation is called the loan to value ratio (“LTV”). Lets look at an example. Your home is worth $250,000 and you still owe $100,000 on a first mortgage. If a lender is willing to lend at 90% LTV, you would multiply the value of the home ($250,000) by 90% LTV (.9), which equals $225,000. Subtract the first mortgage balance ($100,000) from the maximum loan amount ($225,000), and you get $125,000. This is the maximum loan amount of the line of credit in this scenario. Before the credit market problems that roiled the mortgage industry in 2008, it was not uncommon to see financial institutions lend up to or even exceeding 125% LTV. Those days are largely a thing of the past. In todays market, lenders have become much more conservative in their underwriting guidelines.

Who Uses Home Equity Lines of Credit?
Homeowners use equity lines of credit to fund virtually any expense. Homeowners may request this type of loan in order to:

Fund home renovations, such as a bathroom or kitchen remodel

Pay tuition for a child’s education

Pay off other, higher-interest debts

Purchase a new car

Invest in a new business opportunity

Support the family during a period of unemployment

Purchase a second home or rental property

Have funds available for any unexpected emergencies

It’s possible to secure a loan with as little as 10-20% of your home’s value in equity, making a home equity line of credit an attractive option under many circumstances.

Advantages and Disadvantages
There are pros and cons to obtaining home equity lines of credit, and times when this type of loan is more suitable than others. The following guidelines may provide you with a better sense of whether a home equity line of credit is the right choice for your situation.

A home equity line of credit is often preferable to a standard loan because it can be drawn on as needed and will continue to be accessible even after any borrowed money has been paid back, much like a credit card. It’s also possible to get lower interest rates on a home equity line of credit than on an unsecured loan, since your home serves as collateral on the loan. Additionally, because the loan is secured by the equity in your home, interest paid is often tax deductible.

Home equity lines of credit usually offer a variable rate; this can be risky for some borrowers, as the rate is likely to change substantiallyespecially if the loan terms span a prolonged period, such as 5 or 25 years. Another factor to consider is that any home equity loan would have to be paid off in the event you are going to sell your home.

Finally, anyone considering a home equity line of credit should keep in mind that withdrawing a large amount at once can have an impact on your credit rating.

Home equity lines of credit aren’t for everyone, but they do offer an open-ended way to borrow money at a low interest rate and pay it back when your financial situation improves. This type of loan is perfect for someone who is conscientious and able to plan ahead to repay the loan, but it may be problematic for procrastinators or those who prefer to avoid the risk of a variable rate loan.

The characteristics of home equity lines of credit are perfect for this purpose.

In this article we will analyze the concepts of home equity and home equity lines of credit and explain why these particular lines of credit are perfect tools for starting new businesses and what the benefits that these financial products provide are.

Defining Equity

Equity is the difference between the current value of your property and any pecuniary obligations that it is guaranteeing. These obligations can be liens, mortgages, etc. The amount of available equity is obtained by subtracting the amount of the outstanding obligations to the valuation price of the property.

Thus, if you own a property that is worth $120,000 and your current mortgage balance is around $70,000 that means that you still have $50,000 of available equity on your home that you can use for obtaining a loan or line of credit and use it for any purpose you can think of. Following we will analyze home equity lines of credit for starting businesses.

Lines Of Credit for Businesses

Lines of credit are revolving sources of funds that can provide you with all the finance you need for starting a business if they are based on sufficient equity. The idea is that you are granted credit up to a certain amount limit which is guaranteed with your home equity.

In the above example you would count with up to $50,000 on your line of credit to start your own business.

There is no need for you to withdraw the whole amount and as long as you don’t request money, the line of credit won’t generate interests. You’ll only have to pay a small maintenance fee.

Moreover, say you withdraw $10,000, the interest rate will only be charged over that $10,000. Once you repay the amount, it will stop generating interests and you can withdraw that amount or any amount up to the credit limit whenever you want.

As regards repayment, it is also very simple. You will only be required to repay a minimum amount every month, just like with credit cards. This minimum almost always consists on the interests and sometimes a small portion of the principal. This provides you with a lot of flexibility.

When starting a business you can’t be suffering pressure from lenders because you need to concentrate on generating income rather than repaying a loan. Thus, home equity lines of credit provide you with all the finance you need and don’t asphyxiate your business with high monthly payments.

Once your running business generates enough income for you to cope with higher payments, you can start repaying the principal at your best convenience. Moreover, you can easily fix the interest rate (that is otherwise always variable) and turn the home equity line of credit into a home equity loan.

This credit is available at any time during your draw period with convenient access through your Wells Fargo credit card, checking account, ATM, online banking, or local bank. The draw period of a Home Equity Line of Credit is the amount of time the line of credit is open, usually ten years, after which the line of credit is closed and repayment starts. Advances taken out during this draw period may have small monthly payments in which only minimal amounts are paid toward the principle with the rest of the payment going to accrued interest, or interest only payments may be made. Wells Fargo offers plans that allow repayment of the Home Equity Line of Credit loan over a fixed period of time after the draw period has ended. Some of these plans allow up to thirty years repayment time.

Interest of Wells Fargo Home Equity Lines of Credit is variable and tied to the Prime Lending Rate, the rate in which most major banks charge their largest and most credit worthy customers. This variable rate usually has a cap to limit how high of an interest rate can be charged and some have limits as to how low the interest rate can get. Variable rates are subject to quarterly adjustment though some plans offer a fixed interest rate. The interest paid on Wells Fargo Home Equity Lines of Credit is only paid on the funds that are used and is usually tax deductible.

Like Home Equity Loans, Home Equity Lines of Credit have fees that may be charged for taking out the loan. Some plans call for one-time; up front fees while others have annual fees. Plans that offer low monthly payments during the draw period may require a balloon payment at the end of the loan period requiring the entire remaining balance to be paid. Other fees can also apply such as appraisal fee, credit check fee, and closing costs. The Federal Truth in Lending Act protects the borrower by requiring the lender to inform the borrower of all costs and terms when the application is given.