Should I Get a HELOC?

Thankfully, many of our clients are happy with their mortgages. The interest rate, the terms, the peace of mind — all are satisfactory and there’s no motivation to change or refinance. But what happens if there’s a need to use the equity in the home to finance a remodeling project, a large purchase or to just have a “safety net?” A home equity line of credit or “HELOC” can be used to meet these purposes, but should you get a HELOC and, if so, how do they work?

What Is a HELOC?

A home equity line of credit, or HELOC, is most often a second mortgage or junior lien, that “goes behind” your existing (first) mortgage. Unlike a traditional “closed end” mortgage that is fully-amortized, a HELOC usually allows the borrower to draw a balance on a line or limit, then pay it back and repeat the process again. So, where your typical mortgage may start at $400K, for example, and with every payment made will see its balance reduced a little further until completely paid off, a HELOC might have a limit of $50K. Our homeowner may “draw” $35K on the line to purchase a vehicle, then pay it back in the span of a few years and until the balance is at zero. Later, there may be another need for all $50K in order to remodel the kitchen of the home and our borrower could again write a check against the line for that amount. A good analogy for a HELOC is a credit card. You have a limit and you have a balance, and the balance can go both up and down depending on your use and repayment.

As the name would imply, a home equity line of credit allows the homeowner to access the equity in the home. What does this really mean? Let’s use an example. We’ll say our home is worth $500K. The owner has a first mortgage of $400K, so the loan-to-value (LTV) is 80%. The owner therefore has 20%, or $100K, of equity in the home. Some of our HELOC programs allow a combined loan-to-value (CLTV) of 90%, so in this case the homeowner could take a line of credit for $50K (10% of value and a CLTV of 90%). The HELOC now gives the owner access to some of the equity without having to do a cash-out refinance, which might be expensive or, in many cases, impossible.

How Do HELOCs Work?

Let’s first differentiate between a home equity line of credit (HELOC) and a fixed rate second mortgage. The latter is simply a junior lien of (usually) 10, 15 or 20 years that often has a fixed rate and is fully-amortized. You pay it down just like your first mortgage. But a HELOC, as explained above, works differently and as a result, usually has two distinct periods during its full term; the draw period and the payback period. A HELOC’s full term might be anywhere from 15 to 30 years, and some even have a balloon feature, so you have to ask every time. But let’s examine a common HELOC program we offer. It has a 30-year term. The first 10 years are the draw period. You can access the line electronically or with checks. Your payments during the draw period are interest-only, but you can pay the principal balance back as you’d like at any time. After the draw period, the HELOC will convert to a fully-amortized payment for the remaining 20 years and the draw feature ends. During the entire term, the interest rate is adjustable and tracks Prime Rate. The line of credit will have a margin over or under Prime and this combination (index + margin) is considered your fully-indexed rate or “FIR.”

Home equity lines of credit are the most common kind of second mortgage and they can serve many purposes. Because they allow access to the equity in a home without having to actually service any debt, we see many of our clients open a line of credit and save it for a rainy day. Others will use it to replace the roof on their home to assure a rainy day doesn’t end up inside the home itself. Either way, promoting an understanding of how HELOCs work is something we’re happy to share. Get in touch if we can help you unlock the mystery of a home equity line of credit.

Loc, stock and barrel, 

 

Robert J. Spinosa
Vice President of Mortgage Lending
Guaranteed Rate
NMLS: 22343
Cell/Text: 415-367-5959
rob.spinosa@rate.com

Marin Office: 324 Sir Francis Drake Blvd., San Anselmo, CA 94960
Berkeley Office: 1400 Shattuck Ave., Suite 1, Berkeley, CA 94709

*The views and opinions expressed on this site about work-related matters are my own, have not been reviewed or approved by Guaranteed Rate and do not necessarily represent the views and opinions of Guaranteed Rate. In no way do I commit Guaranteed Rate to any position on any matter or issue without the express prior written consent of Guaranteed Rate’s Human Resources Department.

Guaranteed Rate. Illinois Residential Mortgage Licensee NMLS License #2611 3940 N. Ravenswood Chicago, IL 60613 – (866) 934-7283

Unlocking a HELOC Mystery

If you could create a client-facing “tip sheet” for your business, a simple punch list of things to do and not-to-do, what would be on that list? You know, the items that always seem to fly under the radar of public knowledge and wisdom, but the ones that frequently undermine the best-of-intentioned customers? I’m sure all of us have this wealth of “insider knowledge” that we’d love to share with the public and, as a result, save them from the misery and inconvenience of being counted among the unfortunate and unsuspecting.

High on my list would be an explanation of how home equity lines of credit (HELOCs) are treated when a borrower goes to refinance a home. Typically, a borrower would obtain a HELOC one of two ways:

  1. At the time of purchase (as with an 80-10-10 or “piggyback” loan).
  2. At a later date. The borrower would have a first mortgage in place an later add a line of credit in order to do home improvement, consolidate debt, etc.

There’s an important distinction between the two options because in the first case, the funds used from the HELOC are considered “purchase money.” In the second case, well simply, they are not.

For the homeowner who has both a first mortgage and a HELOC, refinancing involves some additional considerations. The borrower may either consolidate the balance on the HELOC with the remaining first mortgage amount, or he may subordinate the HELOC altogether. This second option implies that the HELOC will stay as is, but that the second mortgage lender will agree to a process that allows that lien to stay in second position on the title of the home.

Assuming that we have a borrower who is looking to consolidate a HELOC balance into a single, new mortgage, lenders will first look at the nature of the proposed loan. If it will be a conforming or FHA loan, then any balances that are NOT purchase money, once combined will create a “cash out” refinance — even if the borrower does not get a single red cent back at the time of closing. Again, simply consolidating any balances that were not exclusively used to buy the home (such as with an 80/10/10) mean the new loan will be classified as a cash-out refinance and be priced accordingly — typically with slightly higher rates and more restrictive loan-to-value (LTV) parameters.

If the new loan will be a jumbo mortgage then things get a little more interesting. If the new loan balance will fall above the FHA and conforming limits then many jumbo investors will look at the line of credit itself. Specifically, they will look to see if any draws were taken on the line over the last twelve months. If not, then they will often classify the refinance as “rate and term.” This can be a real benefit to the borrower in the way of lower rates and higher LTVs. Just to clarify, the HELOC in these cases did not need to be purchase money, it just needs to have been recently inactive with respect to its balance increasing. If that holds true, structuring the refinance as a jumbo as opposed to a conforming, if possible, may be a highly beneficial approach and we employ it all the time here in the high-cost environment of the San Francisco Bay Area. But caveat borrower. If you have 11 months of payback on the HELOC that is punctuated by a $1 draw on the line in month 12, you go back to square one or you are looking at a cash-out refinance.

And so this last point is the one I wish I could shout from the rooftops.  If you have a jumbo scenario, and if you have a home equity line of credit that you’re looking to consolidate, try to avoid draws for 12 months before you refinance.

Let me know if any questions any time. We’re here to help you with your jumbo or conforming refinance and we’re here to help unlock a common mystery of the HELOC.

LOC her up, 

 

Robert J. Spinosa
Vice President of Mortgage Lending
Guaranteed Rate
NMLS: 22343
Cell/Text: 415-367-5959
rob.spinosa@rate.com

Marin Office: 324 Sir Francis Drake Blvd., San Anselmo, CA 94960
Berkeley Office: 1400 Shattuck Ave., Suite 1, Berkeley, CA 94709

*The views and opinions expressed on this site about work-related matters are my own, have not been reviewed or approved by Guaranteed Rate and do not necessarily represent the views and opinions of Guaranteed Rate. In no way do I commit Guaranteed Rate to any position on any matter or issue without the express prior written consent of Guaranteed Rate’s Human Resources Department.

Guaranteed Rate. Illinois Residential Mortgage Licensee NMLS License #2611 3940 N. Ravenswood Chicago, IL 60613 – (866) 934-7283