Is Now the Time to Use a HELOC?

The Who, What, When, Where, & Why of Home Equity Lines of Credit

With first lien mortgage rates fluctuating between six and seven percent, many have seen the potential in second mortgages, primarily through home equity loans or lines of credit. Whether referred to as a loan or a line, both offer a way to tap into equity without affecting the ultra-low rate of your first mortgage. The industry has called this the "lock-in effect"

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Despite the higher rates, homeowners continue to borrow using any available means. Recently, Home Equity Lines of Credit [HELOCs] balances have risen by 10% year over year and 25% since 2022. Although this surge in popularity has raised some concerns, it's important to remember that these instruments are still near historic lows since the GFC. Mortgage Jinn examines the five W's of the HELOC to educate you on this traditional yet modern technique.

WHAT is a HELOC?

One way to view a Home Equity Line of Credit is as a large credit card that uses your home as collateral. A credit card is an unsecured debt, with limits primarily determined by your income and credit history. HELOCs operate under similar principles, but their limits depend on the amount of home equity you possess, which is based on your home's current market value and the balance of your first mortgage. Like a credit card, a payment is required when there is a balance. If there is no balance, there is no payment, and therefore no interest expense.

• In contrast to a conventional mortgage, the funds can be accessed as needed from the balance and repaid at any time. The scheduled payment reflects the balance; if the balance is reduced by half, the payment typically decreases by half as well. The interest expense is determined based on the daily balance, summed over the billing period.

• Funds are frequently allocated for home improvement projects but can also be utilized for debt consolidation, educational expenses, or emergencies. Because the money is secured by the home, it typically offers a lower interest rate well below rates from a credit card.

• HELOCs generally have variable rates that are indexed to the prime rate. Home Equity Loan rates are often fixed and based on a term ranging from 5 to 30 years. Similar to first mortgages, longer terms typically result in higher rates. The typical margin on average, it is about 1% over the prime rate. Any margin at prime or below prime is an excellent deal.

  
  

• The interest expense might be tax-deductible, unlike most unsecured debt. However, it probably needs to be invested in enhancing the home's value, with proper documentation. Depending on the balance of the first mortgage, it could eliminate or reduce the deductibility entirely, so consult a CPA.

WHO needs a HELOC?

As the name suggests, Home Equity requires homeownership. You can leverage a primary, secondary, or investment property, but it must be residential real estate. Additionally, similar to most loans originated after financial reform, borrowers seeking a HELOC must demonstrate their ability to repay. Unlike qualifying for a first deed of trust, you must qualify based on a payment calculated at a higher rate and a full draw of the line.

For instance, your line's effective rate might be 9%, with a requested limit of $100,000. The lender could qualify you at 1% to 1.5% of the requested limit, which translates to $1,100 to $1,500, and not the actual statement bill of $900. Additionally, certain credit minimums for scores and payment history will apply. Higher credit scores result in a lower margin relative to the index. Credit tiering can affect the line's size or the Loan to Value Max. Last, expect most HELOCs limitations to 80% of the total collateral, but lenders with a higher appetite may extend up to 95% of the home's value.

HELOCS like to use the Prime Rate as the Index, plus or minus a margin

WHERE to find a HELOC?

That's a great question with a challenging answer. Not all lenders are interested in these types of loans. Wells Fargo Bank, once a popular lender, removed this product from their offerings during Covid with no immediate plans to reinstate. Other major banks may offer them, but restricts the line size or reserve for existing banking customers. Credit Unions could be a good partner, offering several ways to customize them. Mortgage Brokers might have limited capacity for these loans or may charge an hefty fee. Generally, larger banks or credit unions offer the best terms, lower costs, and flexibility regarding property type.

WHEN to get a HELOC?

The ideal time to establish a credit line is when you don't actually need one. If your income is increasing, you have substantial equity, high FICO scores, and no immediate need for funds, secure a HELOC as soon as possible! Banks prefer lending to individuals who aren't in need of money, often providing competitive terms. To enhance many offers, banks frequently give a 0.25% discount to those who set up automatic payments from the originating bank. Similar to a mortgage, your income, assets, and property will be assessed, which requires time. Anticipate at least a 30-day processing period as your chosen lender will need to conduct a title search, verify your employment, and update your insurance.

WHY use a HELOC?

There are numerous benefits in this market that make HELOCs the preferred option. First, they have a lower acquisition cost compared to a traditional mortgage. Additionally, they enable you to leverage your home equity while maintaining the terms of your first mortgage. Furthermore, many HELOCs offer interest-only terms, allowing you to manage expenses with lower carrying costs. However, they typically have a higher cost of funds than the current rate on a30-year fixed mortgage. It's also important to consider them as a 1-month A.R.M.., as the prime rate aligns with the Federal Reserve's short-term policy, leaving you exposed to any increases. These instruments are ideal for short-term expenses that can be paid off in less than a few years. The standard term includes a 10-year draw period followed by a term loan up to 30 years with principal and interest payments. Some lenders offer the flexibility to fix the rate or convert it to a loan before the initial term ends. While there is no prepay penalty, lenders might impose an early termination fee if you close within three years of opening.

Until mortgage rates drop significantly - below 5%, expect balances and use of a HELOC to increase over time. According to recent "Fed-Speak," short-term interest rates are expected to improve throughout 2025, directly reducing the cost of borrowing on a HELOC. It's important to note that unless the HELOC was obtained as a purchase money mortgage on the home's acquisition date, combining it later with a first lien mortgage is still regarded as a "cash-out" refinance. This approach might result in refinancing two loans into one at a slightly higher rate than advertised. It may not be a concern for now, but eventually, your loan officer will hit your with a "?", WHEN did you acquire your HELOC?

Stay Thrifty,

Marid Jinn