HELOCs: leverage your equity without sacrificing your interest rate
A Home Equity Line of Credit (HELOC) is a second mortgage that allows homeowners to leverage their home equity without impacting their existing mortgage. With our HELOC, you can access up to 90% of your home’s value if it is your primary residence (compared to the 70%-80% limit set by many other lenders). For example, if your home is valued at $1,000,000 and you owe $700,000 on your current mortgage, a HELOC can provide an additional $200,000 as a line of credit, reaching 90% of your home’s value ($700,000 + $200,000 = $900,000). For a second or vacation home, the maximum equity you can access is 80% of the home’s value, and for an investment property, it is 70%.
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 your HELOC, and the initial draw amount is how much money you choose to initially pull out at the time the HELOC is opened. Your maximum line amount (i.e., credit limit) is based on your debt-to-income ratio and the current value of your home as determined by either an automated valuation model (AVM) or an appraisal.
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 use your HELOC to either pull cash out (like a credit card cash advance but without the fee) or simply pay for goods or services (like writing a check to a contractor). You may run up the balance of the HELOC 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. During the first 3 years of the HELOC, you are eligible to take draws. You may take as many draws as you’d like up to the HELOC’s “line amount” during these first 3 years. You are not eligible to take any draws after the first 3 years.
You are only required to make minimum “interest-only” payments on your HELOC balance during the first 10 years, but you may also pay down the principal balance if you’d like. After the first 10 years, the loan re-amortizes for the final 20 years, and principal and interest payments become due on the HELOC balance at that time.
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 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 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 90% 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 560 minimum credit score is required (whereas a HELOC typically has a 640 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.
