This article outlines common home equity borrowing terms in easy-to-understand language.
Because there is no real secondary market for home equity loans and lines, there is little standardization of these products across the country. There are, however, a handful of the most basic, common types, and we'll cover those here.
Home equity loans, are most commonly fixed rate and fixed term; normally, 10 and 15-year payback terms, although you might find 5-year or 20-year terms. The longer the loan term, the lower your monthly payments are, but due to the longer interest repayment period, the total cost of the loan is higher.
Terms on home equity lines of credit come in a few different forms:
HELOC advance and repayment terms
Most home equity lines of credit have both an advance term and a repayment term. During the advance term, you typically have unlimited access to your money, and are billed each month for what you have borrowed. During the advance term, many lenders bill you for interest only, where any minimum payment due is sufficient to cover only the interest you are being charged. In these cases, you are not required to pay back any of the principal borrowed, although you can pay back any amount over the minimum payment as a means of replenishing your account back to the maximum line. Advance terms can be any length of time, and are often for 5 or 10 years.
Once the advance term has expired, and if you have built up an unpaid balance, you'll enter the repayment term. Normally, you cannot borrow any more money against the home, and you are required to make payments of both principal and interest in an amount large enough to retire the line within a specified time. Typical advance and repayment terms are 5-year advance, 10-year payback; 10-year advance and 15 year payback; 10-year advance and 20 year payback. When you're shopping, you may find longer and shorter pairs, but most prevalent are the 10/15 or 10/20 varieties.
HELOC floors and ceilings
Since most HELOCs have adjustable or variable interest rates, it's important to consider limitations on interest rate changes. Unlike adjustable rate mortgages, which normally have "initial", "per-adjustment" and "lifetime" caps, lines of credit generally have only a single maximum interest rate you can be charged: the ceiling. By contrast, home equity loans are usually fixed-rate, meaning your rate never changes.
Federal regulations require that credit lines have a ceiling of some sort; however, they don't require the lender to make it very competitive. Most common in the U.S. is an 18% ceiling -- about the rate on your major credit card. But be careful. Some lenders charge their state's usury limit, the maximum interest rate allowable by law. In some states, this can be as high as 25%, offering you very little protection in times of continually rising rates.
While it's not likely that rates will soon get that high, keep in mind that the Prime Rate hit an all-time high of 21.50% in December, 1980; if your loan is Prime plus 1.65% that would yield a rate of 23.15% -- a very uncomfortable level indeed. The ceiling on your interest rate is important, so shop carefully for it. Look for deals; some lenders charge as little as 5% or 6% over the credit line's starting interest rate.
Floors, on the other hand, are a kind of reverse cap; that is, they limit how far your rate can fall. Most floors are about 4% to 5% below your starting interest rate, but some lenders have them set as high as 7 or 8 percent. With an 8 percent floor, your interest rate will never go below 8 percent, so you'll never enjoy the benefit of any continued decline in interest rates. So be sure to ask if there is a floor, and what that floor rate is.
Certain lenders offer a "per-adjustment cap." This cap is most prevalent on lines based on treasury bills or treasury securities that have quarterly or annual adjustments. Since their adjustments are less frequent than the typical monthly prime-based adjustments, these lines are more subject to wide swings in the interest rate from adjustment to adjustment. So, if the lender you're considering offers a treasury-based line, ask about any per-adjustment caps -- usually 1% to 2%.
While this page presents the most common home equity loan and HELOC terms, other borrowing terms can also be important. Termless equity lines of credit, balloon loans and lines of credit and convertible HELOCs are explained in our next article.
Next article: Special home equity terms
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