 Dear
Dr. Don,
My husband and I have a $30,000 HELOC and
we have used $29,730 for home improvements. We
are paying a monthly finance charge of $244, on
average, with a current APR of 9.375 percent. None
of the payment goes toward principal. How do we
pay down the principal? I called the credit
company and they were so confusing in their explanations
that I couldn't understand anything. Please
help me understand this in layman's terms. We
can't get any straight answers or help from the
credit company.
-- Jody Jumble
 Dear
Jody Jumble,
All across America, you could hear homeowners
with HELOCs and ARMs breathe a sigh of relief
when the Federal Reserve's Open Market Committee
lowered its federal funds target rate to 4.75 percent
from 5.25 percent Sept. 18.
HELOCs are typically indexed to the prime rate, and that rate followed the federal funds rate lower to 7.75 percent. You can track federal funds and the prime rate from Bankrate's "Rate Watch: Track leading interest rates" page.
The typical HELOC has interest-only
payments in the early years of the loan. The rate
used to calculate interest expense isn't the annual
percentage rate -- or APR -- but the stated rate
on the loan. If you're paying $244 per month in
interest expense, that rate is currently about
9.85 percent.
How quickly you reap the benefit
on your HELOC depends on the reset terms in the
loan agreement. For most HELOC borrowers, there
shouldn't be more than a month's lag in seeing
a lower rate on the loan, meaning a rate cut in
September becomes effective in October, but since
interest is paid in arrears, you won't see a reduction
in your payment until November.
You can make payments to principal to bring down the balance on your loan. These additional principal payments reduce the outstanding loan balance, resulting in lower interest expense.
If your loan is set up as a direct
debit, then scheduling the additional principal
payments may spawn some technical jargon on how
you schedule the additional principal payments.
Be direct with the lender about what you want
to accomplish and how you can set up additional
principal payments. There typically isn't a prepayment
penalty, but there may be an early closure fee
on loans closed out within the first few years.
Refinancing the HELOC may be an
option if your credit score has improved. A couple
with good to excellent credit scores will
typically pay the prime rate, or even .25 percent
to .5 percent below prime on a HELOC. You're paying
at least a percent over the prime rate on your
loan. An early closure fee will influence whether
or not you need to refinance.
I don't think you need to switch to a home equity loan with its fixed rate and amortized payments. Just work with the lender to start making additional principal payments on the loan.
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