Home Equity Loans & HELOC

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If you have built equity in your home, you may be able to borrow against that equity without refinancing your existing first mortgage.

A Home Equity Line of Credit (HELOC) or home equity loan can provide funds for home improvements, debt consolidation, major purchases, education expenses, investments or other financial needs while allowing you to keep your existing first mortgage in place.

This can be especially valuable for homeowners who already have a low interest rate on their primary mortgage and do not want to replace the entire loan with today's mortgage rate.

Fairhope Mortgage can help you compare a HELOC, fixed-rate home equity loan and cash-out refinance to determine which structure makes the most sense for your situation.

WHAT IS HOME EQUITY?

Home equity is generally the difference between the value of your home and the mortgage debt secured by the property.

For example:

Estimated Home Value: $500,000

Current First Mortgage Balance: $300,000

Estimated Home Equity: $200,000

Having $200,000 of equity does not necessarily mean you can borrow the entire $200,000.

Home equity lenders typically limit the total amount of debt secured by the property based on a maximum Combined Loan-to-Value ratio, or CLTV.

WHAT IS CLTV?

CLTV stands for Combined Loan-to-Value.

Unlike a standard LTV calculation that may look at a single mortgage, CLTV considers multiple loans secured by the property.

For example:

Home Value: $500,000

First Mortgage Balance: $300,000

New Home Equity Loan: $75,000

Total Mortgage Debt: $375,000

CLTV: 75%

$375,000 ÷ $500,000 = 75%

Maximum CLTV requirements vary based on the loan program, occupancy, property type, credit profile and other underwriting factors.

WHAT IS A HELOC?

A Home Equity Line of Credit, commonly called a HELOC, is a revolving line of credit secured by your home.

Instead of receiving all of the money at once, a HELOC generally allows you to borrow funds as needed during an established draw period, up to your approved credit limit.

As you repay borrowed principal, that credit may become available to use again during the applicable draw period.

This makes a HELOC particularly useful when you do not know exactly how much money you will need or when you will need it.

HOW DOES A HELOC WORK?

Assume you qualify for a $100,000 HELOC.

You may not need to borrow the entire $100,000 immediately.

If you initially draw $25,000, your outstanding HELOC balance would generally be $25,000 rather than $100,000.

If you later need another $15,000 for a home improvement project, you could potentially draw additional funds from the available line during the draw period.

Interest is generally charged on the amount actually borrowed rather than the entire unused credit line.

The exact draw, repayment and minimum-payment requirements depend on the HELOC program.

ARE HELOC RATES FIXED OR VARIABLE?

Many HELOCs have variable interest rates.

The rate may be based on an index plus a margin established by the lender.

Because the underlying index can change, the interest rate and monthly payment on a variable-rate HELOC can also change.

Some HELOC programs may offer a fixed-rate conversion feature that allows some or all of an outstanding balance to be converted to a fixed rate.

Features vary substantially by lender and program, so borrowers should understand how the rate is determined, how frequently it can change, applicable rate caps and how payments are calculated before opening the line.

WHAT IS THE HELOC DRAW PERIOD?

A HELOC commonly has two phases:

DRAW PERIOD

During the draw period, you can generally borrow from the available credit line as permitted by the loan terms.

Depending on the program, minimum payments during this period may be based on interest only or on principal and interest.

REPAYMENT PERIOD

After the draw period ends, additional borrowing generally stops and the remaining balance is repaid according to the loan terms.

The monthly payment can increase significantly when a HELOC moves from an interest-only draw period into principal-and-interest repayment.

Understanding both phases is important when comparing HELOC options.

WHAT IS A HOME EQUITY LOAN?

A home equity loan is different from a HELOC.

Instead of providing a revolving credit line, a home equity loan generally provides a specific loan amount at closing.

The borrower then repays that amount over an established term.

Many home equity loans offer a fixed interest rate and fixed monthly principal-and-interest payment, although available structures vary.

A home equity loan may be preferable when you:

Know exactly how much money you need,

Want the funds available at closing,

Prefer predictable monthly payments,

Prefer a fixed interest rate,

Or do not need an ongoing revolving line of credit.

HELOC VS. HOME EQUITY LOAN

HELOC

Type of financing: Revolving line of credit

How funds are received: Draw funds as needed

Interest rate: Often variable

Payment: Can change

Best suited for: Ongoing or uncertain expenses

Ability to borrow again: Generally yes during the draw period, subject to the loan terms

HOME EQUITY LOAN

Type of financing: Installment loan

How funds are received: Lump sum

Interest rate: Often fixed

Payment: Generally fixed when the rate is fixed

Best suited for: Known one-time expenses

Ability to borrow again: No; a new loan would generally be required

WHY USE A HELOC INSTEAD OF A CASH-OUT REFINANCE?

One of the biggest advantages of a HELOC is that it allows you to access equity without necessarily replacing your existing first mortgage.

Consider a homeowner who has:

First Mortgage Balance: $300,000

Existing First Mortgage Rate: 3.25%

Cash Needed: $75,000

With a cash-out refinance, the homeowner might have to replace the entire $300,000 first mortgage while also borrowing the additional cash.

With a HELOC or home equity loan, the homeowner may be able to leave the $300,000 first mortgage unchanged and borrow only the additional amount needed.

For homeowners with low-rate first mortgages, preserving that mortgage can be an important consideration.

However, a HELOC or home equity loan is not automatically better than a cash-out refinance.

The interest rate, payment, closing costs, loan term, amount being borrowed and length of time the borrower expects to carry the debt should all be compared.

HELOC VS. CASH-OUT REFINANCE

A HELOC or home equity loan generally creates a second lien while leaving the existing first mortgage in place.

A cash-out refinance replaces the existing first mortgage with a new, larger first mortgage.

A HELOC may make more sense when:

You have a very low interest rate on your existing mortgage.

You need a relatively small amount compared with your first mortgage balance.

You want access to funds over time.

You expect to repay the borrowed amount relatively quickly.

You want to avoid refinancing your entire first mortgage balance.

A cash-out refinance may make more sense when:

The new first-mortgage terms are attractive.

You want one mortgage payment instead of two.

You need to access a substantial amount of equity.

You prefer long-term fixed-rate financing.

The overall cost of the new first mortgage is more favorable than carrying both loans.

The best comparison should consider the total financing cost rather than simply comparing the advertised interest rates.

WHAT CAN A HELOC BE USED FOR?

Homeowners may use home equity for many purposes, including:

Home improvements

Kitchen or bathroom renovations

Swimming pools

Roof replacement

HVAC replacement

Home additions

Debt consolidation

College or education expenses

Major purchases

Emergency expenses

Investment opportunities

Business purposes, subject to applicable program requirements

Real estate investment

Down payment on another property

The availability of funds does not necessarily mean borrowing is appropriate for every purpose. A HELOC is secured by your home, so the repayment obligation should be considered carefully.

USING A HELOC FOR HOME IMPROVEMENTS

Home improvements are one of the most common uses for home equity.

A HELOC can be particularly useful for renovation projects because construction expenses frequently occur over time.

Instead of borrowing the entire anticipated project cost on the first day, a homeowner may be able to draw funds as contractors and suppliers need to be paid.

Potential projects could include:

Kitchen remodels

Bathroom renovations

Swimming pools

Outdoor kitchens

Patios and decks

New roofs

HVAC systems

Flooring

Room additions

Garages

Landscaping

Energy-efficiency improvements

USING HOME EQUITY TO CONSOLIDATE DEBT

Homeowners sometimes use home equity to pay off higher-interest credit cards, personal loans or other debts.

This can potentially reduce the interest rate or monthly payment associated with those obligations.

However, there is an important tradeoff:

Credit-card and unsecured debt is being replaced with debt secured by your home.

A lower monthly payment also does not necessarily mean lower total cost if the debt is extended over a substantially longer repayment period.

Before using home equity for debt consolidation, compare:

Current interest rates

New interest rate

Monthly payment

Loan term

Closing costs

Total expected interest

Whether the spending that created the debt has been addressed

USING A HELOC TO BUY ANOTHER PROPERTY

Home equity can potentially be used to help purchase another property.

For example, a homeowner may use available equity from a primary residence toward the down payment or closing costs on:

A second home

Vacation property

Rental property

Investment property

Another primary residence

This can allow a homeowner to access capital without selling the current property.

The HELOC payment and outstanding balance may affect qualification for the new mortgage, so both transactions should be evaluated together before funds are drawn.

CAN I USE A HELOC FOR A DOWN PAYMENT?

Potentially.

Borrowed funds secured by another asset, including real estate, may be an acceptable source of funds for certain mortgage transactions when applicable underwriting requirements are satisfied.

However, the payment associated with the HELOC or home equity loan may need to be included in the borrower's debt-to-income calculation.

If the purpose of the HELOC is to purchase another property, it is best to structure both loans together rather than opening or drawing on the HELOC without considering the new mortgage.

CAN I GET A HELOC ON A SECOND HOME?

Potentially.

Some home equity programs permit second homes, although maximum CLTV, credit-score and other requirements may be different from those for a primary residence.

Program availability varies.

CAN I GET A HELOC ON AN INVESTMENT PROPERTY?

Home equity financing may be available on certain investment properties, but options are generally more limited than for primary residences.

Investment-property HELOCs or home equity loans may have different requirements for:

Maximum CLTV

Credit score

Loan amount

Property type

Reserves

Pricing

Program availability should be evaluated based on the individual property and borrower.

HOW MUCH EQUITY CAN I BORROW?

The amount available depends on several factors, including:

Current property value

Existing first-mortgage balance

Maximum permitted CLTV

Credit profile

Income and debt-to-income ratio

Occupancy

Property type

Loan amount

HELOC or home equity program requirements

For example:

Home Value: $500,000

Maximum CLTV: 80%

Maximum Total Mortgage Debt: $400,000

Existing First Mortgage: $300,000

Potential Additional Equity Financing: $100,000

This is only an illustration. A particular borrower or property may qualify for more or less depending on the available program.

DO I NEED AN APPRAISAL FOR A HELOC?

Not necessarily.

Depending on the lender, property and loan amount, the property's value may potentially be determined using:

A traditional appraisal

Desktop appraisal

Automated valuation model

Property valuation report

Other approved valuation method

The lender determines the acceptable valuation method for the transaction.

WHAT CREDIT SCORE DO I NEED FOR A HELOC?

There is no single credit-score requirement that applies to every HELOC or home equity loan.

Credit requirements vary based on the lender, CLTV, loan amount, occupancy, property type and overall borrower profile.

Generally, stronger credit can provide access to more favorable home-equity options, but the complete loan profile should be reviewed rather than assuming that one credit-score threshold applies to every program.

HOW IS HELOC INCOME CALCULATED?

HELOC and home equity borrowers generally must demonstrate sufficient qualifying income to repay the debt.

Depending on the program, income may include:

W-2 employment income

Self-employment income

Retirement income

Social Security

Pension income

Rental income

Other eligible income

Self-employed borrowers may have additional documentation requirements.

Fairhope Mortgage can also evaluate alternative home-equity programs that may be available for borrowers whose income does not fit traditional documentation requirements.

ARE HELOC CLOSING COSTS LOWER THAN A REFINANCE?

They can be, but not always.

Some HELOC programs have relatively low upfront costs, while others may include appraisal, title, recording, origination, annual or other fees.

Some programs that advertise reduced or waived closing costs may require repayment of certain costs if the line is closed within a specified period.

Compare the complete terms rather than relying only on an advertised “no closing cost” description.

IS HELOC INTEREST TAX DEDUCTIBLE?

Potentially, but not simply because the loan is secured by your home.

Federal tax treatment depends on how the borrowed funds are used and current tax law.

Homeowners should consult a qualified tax professional regarding their individual circumstances.

Fairhope Mortgage does not provide tax advice.

SHOULD I GET A HELOC IF I HAVE A 2%, 3% OR 4% FIRST MORTGAGE?

This is one of the strongest reasons to evaluate a second mortgage before considering a cash-out refinance.

If you have a substantial first-mortgage balance at a very low fixed interest rate, replacing the entire balance with a new mortgage at a higher rate could significantly increase the cost of borrowing.

A HELOC or home equity loan allows you to potentially preserve the low-rate first mortgage and finance only the additional amount you need.

That does not automatically make the second mortgage cheaper.

The correct comparison is:

Keep Existing First Mortgage + New HELOC/Home Equity Loan

VERSUS

Replace Existing Mortgage With New Cash-Out Refinance

Compare the combined monthly payments, interest rates, closing costs, loan terms and expected total financing cost.

FREQUENTLY ASKED QUESTIONS

What does HELOC stand for?

HELOC stands for Home Equity Line of Credit.

Does a HELOC replace my mortgage?

Generally, no. A HELOC is commonly placed behind an existing first mortgage as a second lien.

Is a HELOC a second mortgage?

A HELOC secured behind an existing first mortgage is a form of second-lien mortgage financing.

Do I have to borrow the entire HELOC amount?

Generally, no. A HELOC establishes a maximum credit line, and borrowers typically draw funds as needed during the applicable draw period.

Do I pay interest on money I haven't borrowed?

Generally, interest is charged on the outstanding amount borrowed rather than the unused portion of the credit line, subject to the specific HELOC terms.

Can my HELOC payment change?

Yes. Many HELOCs have variable rates, so the rate and payment can change. Payments can also change when the loan transitions from its draw period to its repayment period.

Can I pay a HELOC off early?

Many HELOCs can be paid down or paid off early, but borrowers should review the specific loan terms for early-closure fees, minimum-draw requirements or other provisions.

Can I refinance a HELOC later?

Potentially. Depending on qualification and available programs, a HELOC may later be refinanced, replaced with another home equity product or potentially incorporated into a new first mortgage.

Can I get a HELOC if my first mortgage is with another lender?

Potentially. The existing first mortgage generally does not have to be serviced by the same lender providing the HELOC.

Can I get a HELOC if my home is paid off?

Potentially. If there is no existing first mortgage, a home equity loan or line may be structured as the primary lien against the property, depending on the available program.

Can I use a HELOC for a swimming pool?

Yes, subject to the HELOC terms. Homeowners commonly use home equity for improvements such as pools and outdoor living projects.

Can I use a HELOC to pay off credit cards?

Yes, home equity proceeds may generally be used for debt consolidation subject to program requirements. Remember that doing so converts unsecured debt into debt secured by your home.

Can I use a HELOC to purchase an investment property?

Potentially. Home equity proceeds may be an eligible source of funds for another real-estate purchase, subject to the requirements of both transactions.

COMPARE YOUR HOME EQUITY OPTIONS

Your home's equity may give you several ways to access cash.

Before choosing a loan, compare:

A Home Equity Line of Credit

A Fixed-Rate Home Equity Loan

A Cash-Out Refinance

The lowest advertised rate is not necessarily the least expensive option.

Fairhope Mortgage can compare the amount of cash you need, your current first-mortgage rate, available equity, monthly payments, closing costs and expected borrowing period to help determine which structure makes the most sense.

ABOUT THE AUTHOR

Tom Kalagher | Founder & Branch Manager, Fairhope Mortgage

Tom Kalagher is the Founder and Branch Manager of Fairhope Mortgage, LLC. Based in Fairhope, Alabama, Tom works with homeowners and homebuyers evaluating mortgage and home-equity financing options.

Tom helps homeowners compare HELOCs, fixed-rate home equity loans and cash-out refinancing, with particular attention to whether replacing an existing low-rate first mortgage makes financial sense.

He also works with borrowers using home equity for renovations, debt consolidation, major expenses and real-estate purchases, including borrowers who want to access equity while preserving their existing first mortgage.

Tom Kalagher — NMLS #2028566
Fairhope Mortgage, LLC — NMLS #2561450
Fairhope, Alabama
Phone: (251) 391-5618
Website: Fairhope-Mortgage.com

IMPORTANT

Home equity loan and HELOC availability, interest rates, margins, indexes, draw periods, repayment terms, credit requirements, combined loan-to-value limits, fees and property requirements vary by lender and program and are subject to change. HELOCs commonly have variable interest rates, which means the interest rate and monthly payment can increase or decrease. Borrowing against home equity places a lien against the property and may put the property at risk if the loan is not repaid according to its terms. Not all borrowers or properties will qualify. This information is provided for educational purposes and is not a commitment to lend. Fairhope Mortgage does not provide tax or legal advice.