What is an Interest-Only Home Equity Line of Credit?
An interest only HELOC, much like an interest only home loan, lets you pay the just interest for a fixed amount of time, usually between 5-15 years. Unlike a home loan, however, a HELOC is a line of credit you take out against your home’s equity. This means you’ll leverage the value of your home to take out a line of credit.
Another big difference between an interest-only home loan and an interest only HELOC is that a HELOC is a revolving line of credit. This means that you aren’t given a lump sum of cash but instead are able to take out and pay off various amounts of cash depending on your needs. For the fixed interest-only period, since you’re only paying the interest, you’re not actually reducing the amount owed on your line of credit. You can, however, decide to pay more than just interest payments whenever you feel like it and that money will be deducted from the amount you owe.
HELOCs generally have variable interest rates. This means that interest rates can rise and fall depending on a benchmark rate like the federal fund rate, a rate set by the Federal Reserve, plus a margin determined by the lender. Because of this, the lender will give you two numbers, one will be your starting interest rate, and the other will be the maximum possible interest rate. Usually, your starting interest rate will be between 4% and 6%, but the maximum interest rate can be as high as 20%.
This can be cause for concern, seeing as during your initial payments you’re only paying interest and not reducing the amount you owe at all. So if after five years your interest rate has shot up to 10% and you need to start paying interest plus a chunk of what you owe, you could be in big trouble. Your interest rate may also change depending on whether or not the home you are borrowing against is occupied or vacant.
A HELOC will usually require a minimum credit score of 620, with interest rates improving the higher your score is. You’ll also need to have a debt-to-income (DTI) ratio in around 40% or less. Because the line of credit is being taken out against your house you’ll need to own the house or only have a small amount left on your mortgage. Typically, the line of credit you’re approved for with a HELOC is 85% of the total value of your home, minus any money you have left on your mortgage.
Pros and Cons
One of the huge benefits of an interest-only HELOC is that you’ll be paying very little for the initial fixed term. Not only do not have to pay towards any of the money you’ve withdrawn, but starting interest rates on HELOCs tend to be very low compared to other lines of credit. There also tend to be no closing costs when you take out an interest-only HELOC, meaning you don’t have to pay an application fee and no appraisal costs.
Another great benefit is that you can pay off an interest-only HELOC whenever you want. So if you run into a big chunk of cash all of the sudden you can pay off your line of credit without having to pay years of interest.
How to get an Interest-Only HELOC
Getting an Interest Only HELOC is pretty simple. The main requirement is to own a home with a low outstanding amount on your mortgage, or no mortgage at all. You’ll also need to know the value of your home. It’s important for you to get a couple of valuations on you home before approaching a lender or you may find yourself getting lowballed on your line of credit. Chances are, if you have decent credit and own your own home, it will be a breeze to secure an interest-only HELOC, so it’s important to shop around and make sure you’re getting the best deal possible. Convenience isn’t always the cheapest option, so keep your eyes open and be sure you’re making the right choice before you apply.