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HELOC stand for Home Equity Line of Credit. It is like having a gold or platinum credit card that
is tied to your home. Most HELOCs are 2nd mortgages used to help buyers without enough funds for down payment to keep their
mortgage below 80%LTV (see question on having less than a 20% down payment). For example, if you were buying a home for $300k and were planning to put $15,000 down
(5%), the balance of $285,000 is 95% of the value of the home. You could opt for PMI, or you could do a combo loan with a
1st mortgage of $240,00 (80%LTV) and 2nd mortgage of $45,000 (15%LTV). HELOC's offer several advantages and one big disadvantage. Let's start with the positive side.
Unlike fixed rate 2nd mortgages, HELOCs have a maximum draw amount that can me used again and again.
In the earlier example you could opt for a HELOC 2nd mortgage. You would draw the full amount at closing. Your minimum payment
every month would be the interest due on the outstanding balance. No principal payment is required during the "draw period"
(often 10-15 years). This payment would obviously be less than a P&I payment on fixed rate mortgage with a 15-20 year
payoff. Also, should you follow the advice of your mortgage consultant, you could pay principal reduction every month once
you become comfortable with your new house payments. Let's say you reduce the debt on the HELOC to $30,000 over a five year
period. You would have the remaining $20,000 available to you for home repair or to reduce your consumer debts without having
to apply for it.
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So, what's the downside? HELOCs are adjustable rate mortgages usually tied to the prime rate. Therefore, every time the federal reserve (Alan Greenspan) raises the discount rate, the prime rate changes. Depending
on what period in our history you study, that could be a good thing, or a very bad thing. In 2003 the prime rate changed once,
from 4.25 to 4.00 where it stayed the rest of the year. In 2001 it changed 11 times and ranged from 4.75 to 9.00. In 1980
it changed 38 times and ranged from 11.25 to 20.00. From 2004 to mid 2005 when mortgage rates stayed relatively flat, the
prime moved from 4.00 to 6.75.
Where are they going from here? If we knew that for certain we would trade in the bond market. We
don't know, so we continue to consult with clients on mortgage
solutions and make sure they understand their options and the ramifications of their decisions.
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