If you need to tap into your home equity and you have secured an interest rate in the 2% and 3% range of yesteryear, then it would be quite difficult to relinquish that amazing rate by doing a cash-out refinance on your 1st mortgage. Your alternative option to access some of your home’s equity for cash is to secure a 2nd mortgage. When most people think of a 2nd mortgage, they think of a Home Equity Line of Credit (it can also be termed a HELOC, equityline or line of credit), secured by your home as collateral. However, there is another option which is a Home Equity Loan, or a Fixed Rate 2nd mortgage. Here are the main differences between a HELOC and a HELOAN:
Home Equity Line of Credit (HELOC)
- It works like a credit card, so if you apply and receive a $200k equityline and only “draw” $50k on it, you have a remaining $150k you can use on an as-needed basis
- Your payment is based only on the balance, so if there is no balance, then there is no payment
- The interest rate is adjustable based on Prime rate plus a fixed margin, of which that margin depends on the lender, your credit score and Combined Loan-to-Value ratio. Prime has gone from 3.25% since March 2020 to 7.5% in December 2022. If you have an existing equityline, you have certainly seen higher monthly payments due
- The payment is interest-only, which is helpful with monthly cash flow, but not if your goal is to pay this mortgage down or off
A HELOC is an excellent tool if you need to borrow money against your home equity on an as-needed basis and over a longer period of time. The biggest disadvantage is that the rate and payment can and does fluctuate, and we can certainly expect it to increase in this market.
Home Equity Loan (HELOAN)
- A HELOAN is a fixed rate 2nd mortgage, so the rate and payment is fixed for the life of the loan
- It carries a higher interest rate than 1st mortgages and what the current Prime rate is, but it eliminates the risk of future Prime rate increases
- Depending on the lender, the loan is typically based on a 15 or 20 year term. I have great news and can offer 30 Year Fixed 2nd loans, which is very hard to find among credit unions and banks
- If you know you need a specific amount of cash, this can be a good option since you are required to draw the whole amount and make payments on it immediately
A HELOAN is a great tool if you know the amount you need and take it as a lump sum payment. The biggest disadvantage is that the interest rate is higher than a HELOC (at least to start), and that if you did not need that money right away, your payments start regardless.
I am happy to discuss specific details and numbers with you and provide the cost/benefit analysis.
