The Many Flavors of HELOCs

If you’re like most homeowners, you are reluctant to refinance your current mortgage. Nobody wants to give up their 3% interest rates. This has many borrowers turning to 2nd mortgage products, including Home Equity Lines of Credit (HELOCs) to access their equity for things like debt consolidation, home improvement, and other endeavors. Here’s a primer on the many options in the world of 2nd mortgage financing to explore.

Variable Rate Line of Credit

The most common flavor of 2nd mortgages are variable rate lines of credit. These work a lot like a credit card, but because they are secured against your home, usually enjoy a much lower interest rate than a credit card. You often are even given a debit-card or a checkbook to make it easier to spend the money. Monthly payments are “interest-only” on most HELOCs, at least for a while. At some point in the duration of yoru contract, the line of credit converts to a closed-ended mortgage with a defined amortization (pay off) schedule. in most cases, you will have 10 years to make interest-only payment, followed by a 20-year payback. This moment of conversion from interest-only to a 20-year amortization can be quite a shock, as the payment is likely to increase dramatically. Fortunately, the vast majority of Home Equity borrowers pay off their HELOC, sell their home, or refinance the debt before this ever happens.

Interst rates are usually based on the published prime rate, and you’ll have an addition amount of interest (called margin) added based on your qualification criteria. For example, a well qualified borrower who is only borrowing 60% of their appraised value might be offered a rate of “Prime + 0%,” where another borrower who has a lower credit score and a higher loan-to-value ratio might see a rate of “Prime + 2%.” With terms like these, any time the prime rate moves, your interest rate will move with it. Here is a link if you’d like to check the current prime rate.

For many years, it was standard for HELOC’s to have a 10 year draw term (to coincide with the 10 yr. Interest-only term), meaning you could only pull money out during the first 10 years of the contract. Recently, lenders have begun offering 3-year and 5-year draw terms as a way to make the interest rates a little. In most cases, the interes-only payment term is still 10 years, followed by a 20-year amortized repayment term.

These products are attractive for someone embarking on a construction product or other scenario where the funds will be needed slowly over time. This way a borrower isn’t paying interest on the money long before it’s needed.

Fixed Rate 2nd Mortgages

If you don’t like the idea of a variable-rate, interest-only loan, you may be more inclined to use a fixed-rate 2nd. These are very similar to regular 1st mortgage loans, except the rates are usually higher (because they are viewed as a riskier loan by the banks) and the fees are usually lower. It’s not uncommon to see a well-qualified borrower be quoted a rate that is 3 to 4 percentage points higher than the prevailing first mortgage rates.

Fixed 2nd mortgages come in a variety of terms - with 10 and 20 yr. loans being most common.

This type of loan would be attractive at times when rates are expected to increase, or where a borrower wants to commit to an aggressive payoff plan such as a debt consolidation loan.

Hybrid (Fixed & Variable) 2nd Mortgage

These offer the best of both worlds. You get an open line of credit to use as needed, but each draw is given a fixed interest rate at the time of the draw. Other varieties allow you to make multiple draws until you are ready to “fix-in” the borrowed portion of your line. In most cases, this is allowed multiple times over the 10-year draw period, and is followed by a 20-year amortized payback period.

Fees or No Fees

In most cases the fees requried to get a 2nd mortgage are much lower than the closing costs on a frist mortgage. Often lenders will approve the loans without an appraisal and without full title insurance fees. Expect to pay $500 or less in total fees for a 2nd mortgage product. Many banks will offer a no-fee option in exchange for an early termination fee agreement to cover the fees int he event you pay off the loan early.

I’ll Be Your Guide

Sometimes having a lot of options can be overwhelming. This is where I come in. I make it a point to stay informed on all of hte options the mortgage market has to offer you. I also make it a point to be sure to understand your goals and needs so that I can help you easily make an educated decision with confident. Call me today to discuss your plans and options!