Do Home Equity Lines (HELOC) Typically Have Prepayment Penalties?
- The Federal Reserve Act of 1913 established the Federal Open Market Committee (FOMC) whose members are regional federal reserve chairmen. By law, the FOMC meets at least four times per year and sets the federal funds rate. Since 1994, the prime rate has been three percentage points above the federal funds rate, which is the rate of interest paid by creditworthy banks borrowing from the Federal Reserve and other banks. Most HELOCs have interest rates based on the prime rate.
- Some banks waive HELOC closing costs for customers but recoup the charges if the customer closes the line within two years. The closing costs vary by state but include the appraisal, title insurance, flood certification and taxes. Other banks waive the closing costs if the clients agrees to maintain a balance of $10,000 or more on the HELOC for at least three months. Some banks charge a flat fee not related to closing costs for early payoffs or line closings.
- HELOCs are useful as emergency funds for people with limited cash assets. Most banks issue credit cards connected to HELOCs that consumers can use. HELOC checks and online transfer capabilities also provide convenience. The interest paid on HELOC balances is tax deductible for many people and consequently some use HELOCs to pay for college tuition and other large expenses because of the tax break.
- HELOCs are billed on a monthly basis. Some HELOCs allow customers to utilize the revolving credit line for a period of 20 years, after which a balloon payment is due. Some banks turn HELOCs into conventional term loans after 20 years and the borrowers pay fixed principal and interest payments until the loan is paid off. Generally, the term loans last for 10 or 15 years after the termination of the revolving credit agreement.
- HELOCs require borrowers to make monthly interest-only payments. When the prime rate is low, the payment amounts are minimal, but, if the prime rate rise, the monthly payments rise. Many HELOC agreements allow banks to keep raising rates, in conjunction with the prime rate, to a maximum of 20 percent. Mortgages and home equity loans offer fixed interest and payment amounts and most lenders recommend switching HELOC balances to term loans in rising rate environments.
