How to Calculate Home Equity Line Payment

By Tamon

Home Equity Line of CreditIf you are in the market shopping for or planning to hit the market for the best home equity line of credit, there is a possibility that you need to know how to calculate a home equity payment. Today, this process has been simplified with hundreds of online home equity line of credit calculators or (HELOC payment calculator) which automatically generate a monthly payment spreadsheet. However, knowing how to use your pen and paper to manually calculate your home equity line payment is vital.

In order to calculate your home equity line payments, you have to consider the different periods (draw period and payment period). However, calculating HELOC payments, during both periods, is simple if you have the right information.

As a point of caution, before you take a decision or consider a home equity line of credit, you should weigh carefully the costs of getting it against the benefits. While there are more over hundreds of companies that provide this type of credit, you should conduct a thorough research and shop for the credit terms that best meet your borrowing objectives without posing undue financial risks. And remember, if you fail to repay the amounts you’ve borrowed, plus the interest, that could just mean losing your home.

Before we go on to learn how to calculate a home equity line payment, it’s important for us to understand what a home equity line of credit (HELOC) is about.


What is a Home Equity Line of Credit?

A home equity line of credit (Also known as a HELOC) is a form of revolving credit in which allows you to borrow funds on an as-needed basis against your home. Put another way, it’s a form of mortgage loan where your home serves as collateral. Because a home is often considered a consumer’s most valuable asset, many homeowners choose this form of credit only for major expenses, such as consolidating debt, home improvements, medical bills, buying a car, or education, and choose not to use them for day-to-day expenses.

With a home equity line of credit, you will be approved only for a specific amount of credit. Most credit lenders set the credit limit on a home equity line by taking a percentage, usually 80% of the home’s appraised value and subtracting from that the balance owed on the existing mortgage.

Consider a scenario where the appraised value of home $100,000. If the credit limit is 75%. Then the total credit worthiness will be 75% of $100,000 which is $75,000. This means that, the lender will be willing to loan a total of $75,000 against your house as the collateral. If you still have a mortgage loan on this house worth $25,000, this mortgage loan will be deducted from this amount. Therefore, the potential home equity line of credit would be $50,000

In determining your actual home equity credit limit, the lender will also have to consider your ability to repay the home equity loan, principal and interest, by looking at your credit history, debts, income, and other financial obligations.

Many home equity plans set a fixed period, (e.g. 10 years) during which you can borrow money (draw period). At the end of this period (draw period), you may be allowed to renew the home equity loan. However, if your plan does not provide for renewals, you will not be allowed to borrow additional money once the period has ended. Some plans may allow repayment over a fixed period, the repayment period, such as over 10 years while others may require you to make a full payment of any outstanding balance at the end of the period.

Once approved for a home equity loan, you will most likely be able to borrow up to your credit limit whenever you want, during the draw period. Typically, you will use special checks to draw on your line of credit. Some plans allow borrowers to draw with their credit card or other means.

There may be other limitations on how you use the line of credit. While some plans may require you to borrow a minimum amount, say $500, each time you draw on the line or keep a minimum amount outstanding, others may require that you take an initial advance when the home equity loan is set up.


Variable and Fixed Interest Rates

Home equity line of credit are generally provided at either a variable interest rate (meaning the monthly payment will change as the interest rate changes), or a fixed interest rate (meaning the payment do not change or fluctuate during the whole payment period). Though a home equity provides you with access to a huge amount of money, you may choose not to use the entire amount of money. This way, you will be expected to pay for just what you actually used plus the interest.

However, home equity lines of credits are typically approved on a variable rather than fixed interest rates. The rate is based on a publicly available index (such as the prime rate published in a U.S. Treasury bill rate or in some major daily newspapers). In such cases, the home equity lines of credit rates you pay will change, with respect to changes in the value of the index. Most lenders quote the interest rate you will pay as the value of the index at a particular time, usually the rate at the time of the approval, plus a “margin,” such as 2% points. Because the interest rate is tied directly to the value of the index, it is important to look at the index used, how high it has risen in the past, and how often its value changes. Also important to note is the amount of the margin.

Some lenders sometimes offer a temporarily discounted interest rate for home equity lines of credit, an “introductory” home equity lines of credit rates that is unusually low for a short period, usually 6 months.

Variable rate plans secured by a dwelling must, by law, have a cap (or ceiling) on how much your interest rate may increase over the life of the plan. Some variable rate HELOC lenders limit how much your payment may increase and how low your interest rate may fall if the index drops.

Some lenders, including Bank of America, allow you the option to convert from a variable interest rate to a fixed rate during the life of the loan, or let you convert a portion or all of your outstanding variable-rate balance on your HELOC to a fixed-term installment loan. Payments make on the balance at a fixed interest rate are stable and predictable and can protect you from rising interest rates.


How to Calculate Home Equity Line Payment

Determine How to Use the HELOC Loan. Since HELOCs allows you to borrow using your home equity, you are often able to borrow a substantial amount of money. In some cases, you can get up to 85% of the market value of your home minus the amount left due on their mortgage. This allows you to use the HELOC to cover major expenses such as:

  • Increase the number of rooms to your house.
  • Buy another property.
  • Consolidate debt.
  • Pay for higher education.

HELOC can be used to consolidate debt, however, this can end up being financially destructive if you are not careful. You should instead try to pay off any existing debt, closed those accounts, and then you can go for a HELOC. You may only use your HELOC to consolidate debt if the interest rate on the HELOC is favorable to that of your existing debt.


Compare the two types Home Equity Loan

The two types of home equity loans:

Lump-sum: This is the option whereby you take the total sum of the loan and repay it over time with fixed monthly payments. Your home equity interest rates can be set up-front, and each monthly payment goes to reduce the loan principal and covers some of the interest cost. This is considered a type of amortizing loan.

Line of credit: This is the option whereby you get approved for a maximum amount available, but instead of taking the lump-sum, you instead get a line where you draw only what you need. It is also known as a home equity line of credit (HELOC). This option allows you to make multiple draws of the approved amount, over a determine period (draw period), and make smaller payments for several years (during your draw period) until you have to start making fully amortizing payments to eliminate the loan.

These two home equity loans are similar in most cases. However, the first (Lum-sum) require fixed payments (on both the interest and principal) that begin when the money is borrowed. On the other hand HELOCs allow for a draw period in which the borrower is required pays only for the accrued interest.

Draw periods on HELOCS are usually last between 5 to 10 years, while repayment period is typically between 10 and 20 years.

The home equity interest rates on (Lum-sum) loans are generally lower than those on HELOCs are more flexible than the second mortgage (home equity) loan since it allows for drawn upon need. This makes the HELOC a better choice if you are unsure how much money you will need.


Think about repayment. Again, home equity loan is a risky adventure, therefore, you have to review your financial situation and be sure you will be able to repay the loan before you borrow against your home. Consider your realistic ability (monthly income left after all expenses have been settled) to repay the line of credit, particularly after the draw period. During the draw period, it’s relatively cheap to care of the small monthly interest. However, at the end of the draw period, the huge or “balloon” payment for the value of the credit line may be difficult. Borrowers then have the choice of either paying the balloon payment by refinancing (taking out another loan) or from their savings to cover it. Make sure you consider the effect of these on your finance before going for a HELOC.

Consider all of your living expenses (such as bills, food, mortgage, car payments, etc.), debt, income, and financial goals as you decide for a HELOC.

Despite having the choice to repay only the interest during the draw period, some borrowers choose to repay the principal, either entirely or partially.

Whatever your payment choice during the life of the loan, whether you pay none, a little, or some of the principal amount of the home equity line of credit, when the draw period ends, you may be required to pay the entire balance owed, by making large monthly payments. You may at such instance, consider refinancing your loan with the lender in order to make such huge or “balloon” payment.

Home equity loans will only be beneficial to you if you are able to pay them back.

If you can’t afford to repay the loan, you may end up in more debt. However, make sure the need is worth the loan and the added interest before deciding on the loan.


Know the risks. If, maybe due to some changes (material change) to your financial circumstances, you are unable or fail to make the balloon payment on the HELOC, the lender has the right to reduce or freeze the line of credit without any notice. Worse still, the lender may foreclose your line of credit and upon foreclosure, seize your home. Also, a sudden drop in the market value of your home may force your lender to freeze your borrowing privileges. This means, you will temporarily be unable to borrow more money from your credit line.

Some lenders may also prevent you from renting the home, thereby limiting your possible source of income. If you use a HELOC to pay off other debts, there is a more change that you will still need funds to pay off the HELOC. This will only mean drowning yourself into deeper debts.  When the draw period ends and the repayment period begin, the minimum monthly payment can get too high to afford the payment (cause by variable interest rate). Be aware of these risks before opening a HELOC.


How to Calculate Home Equity Line Payment: During the Interest Only Payments (Draw Period)

Know the period in the life of the loan: It’s important to know the period you are in the life of the loan. This is because some HELOC lenders will allow interest only payments only during the draw period, usually the first 5 to 10 years.

The paperwork for your loan: Locate all the paperwork on your loan. You need the information on it to calculate your payments. The information you need, includes the interest rate and the outstanding charged. 

For example, assuming that you have a HELOC on which you currently have drawn out $100,000. This HELOC charges an interest rate of 5%. You are currently preparing to receive a bill for the month of July, so you will be paying interest for 30 days. Note that interest is calculated a daily base.

Determine your outstanding balance. The outstanding balance is not the maximum or approved amount of the loan. It is only the fraction of the loan you have actually "drawn" or used. Specifically, it is the average daily balance for the month, which can be determined by summing up every daily balance on the HELOC and dividing by 30 (the number of days in the month).

Determine your daily home equity interest rates. If the rate is listed as a percentage (that is, 5%), start by converting it to a decimal by dividing by 100 (5/100 = 0.05). Note that 5% is the annual interest rate. To obtain the daily interest rate, divide by 365. In this our example, that would be 0.05/365, or 0.0001374.

Most lenders tied their interest rates to a government-standard interest rate, such as the prime rate published in a U.S. Treasury bill rate or in some major daily newspapers. In such cases, the home equity lines of credit rates you pay will change, with respect to changes in the value of the index. Most lenders quote the interest rate you will pay as the value of the index at a particular time, usually the rate at the time of the approval, plus a “margin,” such as 2% points.

If this is the case, you may need more work in order to calculate your interest rate. You have to know the margin that is in use and add it to the current prime rate. For instance, assume in this case that the current prime rate is 3.5% and your margin is 1.5%. This sets your interest rate at 5%.

Determine the daily interest payment. To determine your daily interest payment, multiply the total borrowed (or drawn) by your daily interest rate. In our example, this would be 0.0001374*$100,000, = $13.74.

Determine your monthly payment. To obtain the amount you have to pay for each month, multiply the daily interest by the number of days in the given month. If we consider our example, our month is July which has 31 days. Thus, $13.74*31 = $425.94. This is your monthly payment if you are still in your draw period.


How to Calculate Home Equity Line Payment: During the Repayment Period

Determine your annual home equity interest rates. Many home equity line of credit lenders charges a variable interest rate that is set to another market rate, such as the prime rate. This implies that your interest rate fluctuates or changes according to this market rate and can be vastly different between months or years. Also, many lenders charge a higher interest rate compared to the market rates. The difference is known as the margin. Your interest rate is calculated as the sum of the market rate and the margin.

Assume your margin charges a 1.5% and your HELOC is tied to the prime rate, which is currently at 3.5%, your annual interest rate will be 3.5% + 1.5% = 5%.

Note that because the interest rate change (variable rate), this will have to be recalculated each month.


Determine your monthly home equity interest rates. To do this, start by converting your annual rate (in our example 5%) to decimal by dividing by 100. That is 5/100 = 0.05. Next, divide your annual rate by the total number of months (12) to obtain a monthly interest rate and add 1 to your result. This would be 0.05/12, or 0.00417. Adding 1 to your monthly interest rate gives 1+0.00417=1.00417


Determine your total number of payments. How long do you plan to spend paying your HELOC? Know this number. Multiply this number by 12 to get the total number of monthly payments you will make. If we consider a 10 years HELOC repayment period, then the total number of payments would be 10*12 = 120 payments.


Raise monthly home equity interest rates to the negative power of the total number of monthly payment. This may sounds like a complicated mathematics but it’s not. Simply enter your converted monthly rate (1.00417) into your scientific calculator and press the exponent key{displaystyle x^{y}}. Next, press the negative sign (-) and enter the total number of monthly payments (120 in the example) which would look like (-120). Press enter to get your answer. 1.00417^-120 = 0.607.

Deduct your result from one. Subtract the result from the last step from 1. In our example, this would be 1-0.607 = 0.393.

Divide your monthly interest rate by the result. In this step, you are using the monthly interest rate (without the added one). If we consider our example, the monthly interest rate would be 0.00417. Divide this by the result of the last step. Thus, 0.00417/0.393 = 0.0106.

Multiply your result by your outstanding HELOC. If we consider that our outstanding balance on your HELOC is $200,000, your monthly payment during the repayment period would be 0.0106*$100,000, = $2,120.


How to Calculate Home Equity Line Payment: Useful Tips

You may choose to pay toward the principal each month even when you are still in the draw period. This is a better way to lower your principal so much such that, by the end of the draw period, your repayments will be made on a lower amount. Also, each time you pay on your principal, you lowered the amount available to you for use.

When discussing a variable interest rate with your loan agent, make sure that you are told what the interest cap will be. The interest cap or ceiling is there to make sure that the rate will never go above a certain percentage, even if the market rates fluctuates above that rate.


How to Calculate Home Equity Line Payment: Precautions & Warnings

If you are still planning to apply for a HELOC loan, it is a good idea to use an HELOC payment calculator (an online HELOC payment calculator) to compare monthly payments and rates based on your budget. However, bear in mind that interest is not the only factor when calculating how much your repayment will be. The HELOC will also have other fees (such as transaction fee) associated with it and those must be factored into your outstanding amount. Make sure you discuss this with a loan agent for proper.


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