What’s different about a HELOC?
My boyfriend’s parents have a home right now that is extremely upside down. I told them that it might be best to just walk away b/c a loan modification probably wouldn’t help them much.
Their accountant has advised them to seek a modification first, then think about walking away as a last resort. He also told them something that I do not understand.
He told them that even if they walk away from their loan, they need to keep paying their HELOC. They have a first and a second (the HELOC). Why would they need to keep paying on their home equity line of credit if it is only secured against that particular property? Is there something different that will affect them?
NOTE: My boyfriend’s father owns a business, but it is incorporated. Does the accountant think that it will have a bearing on this?
I just need opinions or insight on this matter.
The HELOC was taken out at the same time as the 1st. WAMU (or the agent) informed them that they had to do it this way?
I believe that it had something to do with being a Fannie/Freddie loan, which has a maximum, and they put the remaining 40 or so grand on the HELOC.
Does this make a difference?
Usually the only type of loan forgiven in foreclosure is an acquisition loan (used to buy the home). A HELOC is a flexible loan they likely got after that to take cash out of the home, so it does not go away if they lose the collateral (the home in foreclosure) unless the foreclosure auction sale is enough to cover the mortgage and the HELOC.
HELOC stands for home equity line of credit, or simply “home equity line.” It is a loan set up as a line of credit for some maximum draw, rather than for a fixed dollar amount.
For example, using a standard mortgage you might borrow $150,000, which would be paid out in its entirety at closing. Using a HELOC instead, you receive the lender’s promise to advance you up to $150,000, in an amount and at a time of your choosing. You can draw on the line by writing a check, using a special credit card, or in other ways.
HELOCs have a draw period, during which the borrower can use the line, and a repayment period during which it must be repaid. Draw periods are usually 5 to 10 years, during which the borrower is only required to pay interest. Repayment periods are usually 10 to 20 years, during which the borrower must make payments to principal equal to the balance at the end of the draw period divided by the number of months in the repayment period. Some HELOCs, however, require that the entire balance be repaid at the end of the draw period, so the borrower must refinance at that point.
Because the balance of a HELOC may change from day to day, depending on draws and repayments, interest on a HELOC is calculated daily rather than monthly. For example, on a standard 6% mortgage, interest for the month is .06 divided by 12 or .005, multiplied by the loan balance at the end of the preceding month. If the balance is $100,000, the interest payment is $500.
On a 6% HELOC, interest for a day is .06 divided by 365 or .000164, which is multiplied by the average daily balance during the month. If this is $100,000, the daily interest is $16.44, and over a 30-day month interest amounts to $493.15; over a 31 day month, it is $509.59.
HELOCs are convenient for funding intermittent needs, such as paying off credit cards, making home improvements, or paying college tuition. You draw and pay interest on only what you need.
Upfront costs are also relatively low. On a $150,000 standard loan, settlement costs may range from $ 2-5,000, unless the borrower pays an interest rate high enough for the lender to pay some or all of it. On a $150,000 HELOC, costs seldom exceed $1,000 and in many cases are paid by the lender without a rate adjustment.
Some HELOCs are convertible into fixed-rate loans at the time of a drawing. This is a useful option for borrowers who draw a large amount at one time.
The major disadvantage of the HELOC is its exposure to interest rate risk. All HELOCs are adjustable rate mortgages (ARMs), but they are much riskier than standard ARMs. Changes in the market impact a HELOC very quickly. If the prime rate changes on April 30, the HELOC rate will change effective May 1. An exception is HELOCs that have a guaranteed introductory rate, but these hold for only a few months. Standard ARMs, in contrast, are available with initial fixed-rate periods as long as 10 years.
HELOC rates are tied to the prime rate, which some argue is more stable than the indexes used by standard ARMs. This is an illusion, however, arising from the fact that the prime rate doesn’t change from day to day. In 2003, it changed only once, to a low of 4% on June 27. However, in the next three years it changed 17 times, by .25% each time, reaching 8.25% on June 29, 2006. In 1980, it changed 38 times and ranged between 11.25% and 20%.
In addition, most standard ARMs have rate adjustment caps, which limit the size of any rate change. And they have maximum rates 5-6% above the initial rates. HELOCs have no adjustment caps, and the maximum rate is 18% except in North Carolina, where it is 16%.