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
October 20, 2003
