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October 20, 2003
"Do I shop for a HELOC in
the same way as I would shop for another mortgage?"
No, shopping for a HELOC is very different
from shopping for a standard mortgage. In most respects, it is simpler, if you
know what you are doing.
A HELOC is a line of credit, as opposed to a
loan for a specified sum, and it is always adjustable rate. The bad news about
that, which I discuss in What
Is a HELOC, is that HELOCs provide borrowers with much
less protection against interest rate increases than standard ARMs.
The good news is that HELOCs are easier to
shop for. The major reason is that important features are the same from one
lender to another.
*The interest rate on all the HELOCs is tied
to the prime rate, as reported in the Wall Street Journal. In contrast, standard
ARMs use a number of different indexes (LIBOR, COFI, CODI, and so on) which
careful shoppers have to evaluate.
*The interest rate on the HELOCs adjust the
first day of the month following a change in the prime rate, which could be just
a few days. (Exceptions are those HELOCs with an introductory guaranteed rate,
but these hold only for 1 to 6 months). Standard ARMs, in contrast, fix the rate
at the beginning for periods ranging from a month to 10 years.
*The HELOCs have no limit on the size of a
rate adjustment, and most of them have a maximum rate of 18% except in North
Carolina, where it is 16%. Standard ARMs may have different rate adjustment caps
and different maximum rates.
The critical feature of a HELOC that is not
the same from one lender to another, and which should be the major focus of
smart shoppers, is the margin. This is the amount that is added to the
prime rate to determine the HELOC rate. Many
if not most lenders do not volunteer the margin unless they are asked.
Here is what can happen when you don�t ask.
Borrower X, who provided me with his history, was offered an introductory rate
of 4.5% for 3 months. He was told that after the three months the rate
"would be based on the prime rate." At the time the loan closed, the
prime rate was 4%. Three months later, the prime rate was still 4%, but the rate
on his loan was raised to 9.5%. It turned out that the margin, which the
borrower never asked about, was 5.5%!
WARNING: Do not assume that the difference
between your HELOC start rate and the prime rate is the margin. It may or may
not be. Ask. Bear in mind, as well, that the margin varies with credit score,
ratio of total mortgage debt to property value, documentation and other factors.
You need the margin on your deal, not the margin they are advertising
which is their best deal.
Truth in Lending (TIL) on a HELOC is a
travesty. It requires that borrowers be given an APR, which is the same as the
interest rate. The borrower described above was given an APR of 4.5% early on,
and when his rate jumped to 9.5% he was told that his new APR was 9.5%. TIL does
not require disclosure of the margin.
If the HELOC will be used to meet future
contingencies rather than to refinance an existing mortgage, the shopper needs
to know whether there is a minimum draw at closing, or a minimum average loan
balance. Lenders don�t make any money unless the HELOC is used, but they are
not always forthcoming about this. Borrowers who are uncertain about future
usage don�t want to be forced to borrow money they won�t need.
Last and least important are the fees.
Upfront fees are the same types as on standard mortgages, except that HELOC
lenders seldom charge points, and third party fees tend to be small and are
often paid by the lender. In addition, there are some uniquely HELOC charges
that you should factor in. These include an annual fee, usually $25-$75 and
often waived the first year; and a cancellation fee, perhaps $350-$500, which is
usually waived if the account stays open for 3 years.
Here is your checklist: make sure the figures
you get apply to your deal.
1. Introductory rate and period
2. Margin
3. Minimum draw
4. Required average balance
5. Upfront lender fees
6. Upfront third party fees
7. Annual fee
8. Cancellation fee
Copyright Jack Guttentag 2003
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