HELOCs: leverage your equity without sacrificing your interest rate
A Home Equity Line of Credit, or HELOC for short, is a second mortgage that enables homeowners to tap into their home equity without affecting their primary mortgage. Typically, the maximum amount of equity you can tap into with our HELOC is 95% of the value of your home (many other lenders cap this at 70%-80%). So, if your home is worth $1,000,000 and you owe $700,000 on your current mortgage, a HELOC will allow you to access an additional $250,000 via a line of credit ($700k + $250k = 95% of the home’s $1MM value).
How does a HELOC work?
A HELOC has both a “line amount” and an “initial draw amount.” The line amount is the maximum credit limit for the HELOC, and the initial draw amount is how much money you choose to initially pull out at the time the HELOC is opened. During the first 3 or 10 years of the HELOC, you may take as many draws as you’d like up to the HELOC’s “line amount” (i.e., credit limit). A HELOC with a 3-year draw period generally has a slightly lower interest rate than a HELOC with a 10-year draw period, but you may choose either option.
Think of a HELOC like a credit card (with a much better interest rate) where your “line amount” is like your maximum credit card limit, and the “draws” would be any time you tap into your HELOC and pull money out (similar to purchases made on a credit card). You may run up the HELOC balance and pay it down as often as you’d like – just as you can with a credit card.
The HELOC is a 30-year loan. You are only required to make minimum “interest-only” payments on your HELOC balance during the first 3 or 10 years, but you may pay down the principal if you’d like. After the first 3 or 10 years, the loan re-amortizes for the remaining 20 or 27 years, and principal and interest payments become due. After the initial 3-year or 10-year draw period, the option to take additional draws is no longer available.
The HELOC is an adjustable-rate mortgage (ARM) that moves in lockstep with the Prime Rate and has a ceiling (maximum) interest rate of 18%. Whenever the Fed hikes or cuts the Federal funds rate, the interest rate on HELOC adjusts accordingly.
What’s the difference between a cash-out refinance and a HELOC?
Here are the major benefits when considering whether a HELOC or a cash-out refinance is right for you.
HELOC:
• May be a better option if you have a very low interest rate on your current mortgage – since a HELOC is a new second mortgage, you will not lose the interest rate on your current mortgage
• More flexibility, as you can borrow as little or as much from the line of credit as you’d like during the first 3 or 10 years
• You don’t pay interest on money that you don’t borrow, so you may leave the HELOC dormant and only use it when you need the funds
• During the first 3 or 10 years since you are only required to make minimum “interest-only” payments during this time (but you may pay down the principal if you’d like), which may result in a lower monthly payment initially
• Can tap into 95% of your home’s equity with a HELOC vs. 80% with a cash-out refinance
Cash-out refinance:
• May be a better option if you don’t currently have a very low interest rate on your current mortgage, as a cash-out refinance will replace the interest rate on your current mortgage
• A cash-out refinance provides the advantage of a fixed-rate mortgage, as opposed to a HELOC which typically comes with an adjustable interest rate.
• You know exactly what your principal and interest payment will be for the entirety of the loan term, whereas the payment on a HELOC may fluctuate when your balance changes or when interest rates move in either direction
• Only a 580 minimum credit score is required (whereas a HELOC typically has a 660 minimum credit score requirement)
• Only one lender to repay every month vs. two if you take out a HELOC as a second mortgage
How do I know which is better for me?
While I always recommend talking with an experienced mortgage broker before making any final decisions, there are a few indicators that can help guide you in the right direction. For example, if you have an extremely low interest rate on your current mortgage and do not need access to a large amount of your equity, a HELOC will likely be the better option for you. However, if your current interest rate is on the higher side or you are paying PMI (or have an FHA loan), a cash-out refinance may be the way to go as you could possibly put yourself into a better loan while simultaneously tapping into your equity.
Another consideration is your personal risk tolerance. While HELOCs have many benefits, they also do carry a bit more risk considering they are adjustable-rate mortgages with a maximum rate of 18%. If you are looking to pull out hundreds of thousands of dollars in equity, you will want to evaluate whether you feel comfortable carrying that much debt on an adjustable-rate mortgage vs. doing a fixed-rate cash-out refinance even if it means sacrificing your current interest rate.
Ultimately, this is a big decision and one you do not need to make alone. The best thing you can do is contact us so that we can dig into the details of your individual situation. Even if you aren’t quite ready to get the ball rolling, we’d love to have a discussion to help solidify a strategy around your short and long-term goals!
Working with Solcosta Home Loans
• Since we are a mortgage broker and not a bank, we have the ability to shop multiple lenders to get you the best deal possible.
• We offer a wide variety of loan products, and we can help you find the loan that is right for you!
• We are fast and efficient and have the ability to close most of our loans in 18 days or less.
• We are locally owned and operated in Northern California. That means when you call or email us, you will be speaking with us directly.
