Borrowers in need of cash often wonder if they should get a Home Equity Line of Credit (HELOC) or if they should just refinance into a larger first mortgage with “cash out.”
The answer is “it depends.”
HELOCs are usually tied to Prime Rate, which has been at 5% for several months and will likely drop to 4.75% in response to the reduction in the Fed Fund’s rate yesterday.
HELOCs also have margins on top of Prime Rate that range from 0% (for combined loan to value ratios under 80%) up to 3% (for loan-to-value ratios of 95% and lower credit scores).
Hence, HELOC interest rates are currently much higher than 30 year fixed mortgage rates.
So, why take a HELOC ever?
Cash Out refinances can have 1/8% to 1% higher rates (depending on credit score and loan-to-value) than do “rate and term” refinances.
So, borrowers should avoid cash out loans when they can – unless they have substantial equity (under 60% loan-to-value).
We recommend HELOCs When:
- Borrowers only need a small amount of cash and/or can pay off the balance relatively quickly – with a pending bonus, asset sales, inheritance, accelerated payments, etc.
- Borrowers lack sufficient equity (CA Only). Cash out first mortgages in California are usually not available for borrowers when loan to value ratios are above 80%, so HELOCs are often the only option. In addition, cash out mortgages have substantially higher rates when loan-to-value ratios are over 75%. In Texas, all home equity programs are limited to a combined loan to value ratio of 80%.
- Borrowers need flexibility. Unlike a first mortgage, HELOCs can be drawn against and paid off over and over, and many borrowers need this type of flexibility. For example, I had dozens of contractor clients who all used equity lines as sources of working capital. They would borrow against them during slow season or while completing large projects, then pay them off when they were paid.
- Blended rate is lower than current first lien cash out rates. When a homeowner has a current first lien and takes out a HELOC behind it, we calculate their “blended rate” (an expression of both loans’ interest rate as one singular rate of interest) and compare it to current first lien cash out rates. If the blended rate is lower, a HELOC behind their existing first lien makes more sense than a new first lien cash out loan. This, of course, does not take into account that over time the HELOC rate will vary and subsequently so will the blended rate.
In most other situations, when 30 year fixed rates are this low, borrowers should obtain cash out loans.
Jay Voorhees
Founder/Broker | JVM Lending
(855) 855-4491 | DRE# 01524255, NMLS# 335646
