He is in his early thirties – and he has a family to support, about a half-million in equity, a very low rate first mortgage, an excellent job, and an older home that needs a lot of work.
Because his purchase was relatively recent and because he put a lot of money into his home, he does not have as much liquidity as he might like (despite a high net worth and income) for rainy days, more home improvements, etc.
So, I wrote that blog for him, and in response, he asked me today why he should get a HELOC instead of a 2nd mortgage. And that too made for perfect blog fodder!
HELOCs are far better options than 2nd mortgages – in most cases – and here’s why:
As a quick reminder, a HELOC or Home Equity Line of Credit – is a line of credit that is attached to a home with a lien, and that has a credit limit. Borrowers can use the line to borrow up to the limit or they can borrow nothing at all and just maintain the line for when they actually need the cash. Borrowers can also pay down the line, after they borrow, and re-borrow again in the future.
A 2nd mortgage is a mortgage that is recorded behind the first mortgage, and that is paid out entirely up front with no “revolving” option – meaning borrowers cannot re-borrow funds once they pay down the loan.
- Flexibility. HELOCs are simply far more flexible than 2nd mortgages because of the revolving option. Borrowers who do not need to tap into the bulk of their equity at the moment are better served with a HELOC because they can let it sit idle until they need funds. 2nd mortgage borrowers will get all of their funds up front, whether they want them or not.
- Only Pay Interest For Amount Borrowed. This relates to the above item, but if borrowers don’t need all of the funds now, a 2nd mortgage is much less desirable because borrowers will be paying interest for funds they don’t need.
- Far Cheaper. Most HELOCs are effectively “free” or very low cost, while 2nd mortgages always come with substantial points and fees that can easily add up to several thousand dollars.
- Lower Interest Rates. 2nd mortgages usually have fixed interest rates that are several percent or more higher than prevailing 1st mortgage rates. HELOCs, in contrast, are usually tied to Prime Rate with “margins” (a HELOC rate is usually Prime + the “Margin”) that range from 0 to 3%, depending on one’s credit score and the combined loan to value ratio or CLTV. CLTV = (1st mortgage + 2nd mortgage or HELOC)/Home Value. Most HELOCs though have margins in the 0% to 1% range, putting HELOC rates in the 4% to 5% range currently, as Prime Rate is 4.0% right now (as of the date of this blog). So, while HELOC rates are adjustable instead of fixed, adding some additional risk, the rates are almost always much lower than 2nd mortgage rates.
- Availability. HELOC offerings are ubiquitous, while competitive 2nd mortgage offerings are few and far between. Many borrowers will be hard-pressed to even find a lender that offers 2nd mortgages.
