There are dangerous differences between a HELOC mortgage and a traditional home equity loan. Ignorance of HELOC mortgage differences in home equity loans can cause real trouble.

So, let’s get started unraveling those dangers….

A HELOC mortgage is a line of credit securitized by the equity in your house and sits usually in second lien position. A Fixed Home Equity Loan is not a “line of credit”, but a standard fixed term, fixed rate, fixed payment loan that also sits in second lien position.

A HELOC mortgage rate is always adjustable and that is the first dangerous difference from the fixed home equity loan. The HELOC rate adjusts usually by combining the Prime rate plus a margin. The HELOC mortgage is usually quoted as “Prime plus 1″ meaning your HELOC rate will adjust and stay at 1% above the Prime Rate forever.

The second dangerous difference of a HELOC mortgage is that they are amortized interest only or worse, like a credit card. Either way, you will keep paying the monthly amount and pay down no principal.

The third danger of a HELOC loan which differs from the fixed home equity loan is the standard presence of a pre-payment penalty. Most HELOC loans contain a clause that states you owe them a fee or penalty for paying off the loan before a set time has elapsed. It can be as long as 5 years, but more commonly the duration is 3 years. The penalty fee can be as little as a $100, or as much as 3% of the initial HELOC mortgage amount.

Ouch!

The fourth danger to watch out for is the non-usage fee. This is a fee that gets triggered once you’ve paid down the HELOC loan to zero, but don’t close the line. The HELOC loan stays open but you haven’t borrowed anything, therefore, the bank is not making any interest, so they hit you with a non-usage fee. Once again, it could be only a few hundred bucks but that’s a hefty sum when it could easily be avoided. And of course, there are no such fees possible on a fixed home equity loan since it’s not a line of credit.

The last danger is the no caps element of the HELOC mortgage. A HELOC rate adjusts usually without rate caps so your HELOC mortgage payment could adjust upward with no end in sight. This is one of the most dangerous differences in that the HELOC rate can increase over time but the fixed home equity loan rate by definition can’t.

One way a HELOC mortgage becomes more appropriate is when you know you’ll be paying it off quickly. Also for small business owners a HELOC loan is usually a cheaper way to obtain business capital without the hassle.

But for most of you (not the business owners) a fixed rate rate home equity loan is best and the best provider I’ve found for these are small local banks or credit unions.

Good Luck!

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