HELOCs & Why I Have One

Drew’s article about home equity and GDP inspired me to write about how to help borrowers tap into their home equity. Most readers are familiar with a Home Equity Line of Credit, commonly referred to as a HELOC, but there are two major misconceptions about HELOCs we often hear from borrowers. For the discussion below, the assumed property with a HELOC is a primary home or non-rental property.

Two Common Misconceptions:

• My home has tons of equity, and I should be able to access it instantly with a HELOC, right?
• When I close on my HELOC, I must take or withdraw the funds, right?

For the first misconception, if your home has equity—and maybe it’s a significant amount of equity—this doesn’t mean you can instantly access this equity with a HELOC. For example, if a borrower owns a home and the home is worth $1,000,000 with a $500,000 mortgage, this doesn’t mean borrowers can access this equity just because it’s there. Borrowers will have other underwriting criteria that they must meet before they can obtain a HELOC.

A HELOC is a revolving line of credit that allows homeowners to use the equity in their current home for personal use, and it’s common for investors to use this equity or funds in their primary home for a down payment on a second home or investment property. HELOCs are different than regular mortgages in several ways, and one of the differences is the mortgage payment. With a HELOC, the payment for the first 10- or 15-year period is an interest-only payment. The interest-only payment requirement is often viewed as a positive when borrowers are using HELOC funds to purchase an investment property, especially when there is an effort to keep payments as low as possible and offset mortgage costs with rental income.

It can be challenging for a borrower to qualify for a HELOC because underwriting uses a higher mortgage payment than the actual payment required. This is known as a qualifying payment, and calculations for qualifying payments will vary from lender to lender. Let’s use a $100,000 HELOC as an example, which has an interest-only payment of $605. An underwriter’s calculation will use 1.5% of the loan amount as the qualifying payment or $1,500 for the borrower’s mortgage payment. This $1,500 payment is significantly higher than the actual payment of $605 and makes it difficult for borrowers to qualify. Not all lenders use this calculation method above, but all lenders use a qualifying payment that is higher than the actual payment.  

The second misconception or misunderstanding is that when a borrower closes on a HELOC, they have to withdraw these funds right away, which is not true. I personally have a HELOC, and for the past three years, I have paid nothing to access my home’s equity. The funds from my HELOC are available at a moment’s notice when needed, but I’ve not had a reason to withdraw these funds, and therefore, I have no payment.

As suggested above in rental markets like the Outer Banks, borrowers often use a HELOC for their down payment funds. A borrower may be thinking they will use a HELOC to purchase their vacation house, but they have not started the loan process to obtain a HELOC until they find the right vacation home. Then, they finally find their perfect vacation home and tell us their plan of using a HELOC for a down payment. In this case, starting the HELOC loan process on a borrower’s primary home and initiating the loan process for their beach house at the same, makes it very difficult and stressful to obtain both loans so quickly. We have closed both transactions successfully in the past within a short timeframe such as 30-45 days, but it’s likely one of the closings will be delayed. Additionally, two loan processes at the same time are very stressful to the borrower and often confusing. A proactive approach is to obtain a HELOC in advance of making an offer on another home. Then, the real estate closings become much more seamless versus having two loans being processed at the same time.

The last hypothetical scenario to mention is a borrower who currently lives in their primary home and intends to sell their current primary to then purchase a new primary home. When a client has to sell their current home to then purchase a new home, the offer is contingent on their current home being sold. In a competitive market such as Raleigh, NC many sellers may be less willing to accept a contingent offer, so it’s best to have a solution upfront. In this type of scenario, it’s common that the client’s current home is not even listed on the market yet. Also, the borrower may not want to move from one residence to another so quickly. I can understand moving your whole life on a weekend sounds like a nightmare for an adult, although it could be a fun memory as a child. Typically, a borrower in this scenario has these types of characteristics or desires:

• They need the equity or cash out of their current home to purchase their new home and do not have enough time to sell it.
• They do not want to move right away due to logistics or timing.
• They may want to consider keeping both houses where the previous primary home could be an investment property.

All of these desires could be solved if a borrower obtained a HELOC in advance. Most of the time a borrower does not have a HELOC in advance. This results in a more complex, stressful scenario, with again two loan processes happening at the same time. You may be thinking, but what about a bridge loan as a solution? Many lenders have a cap for their bridge loan of $250,000, which is not large enough to purchase their new primary home. First Heritage is the first lender I have found that really has a unique solution, where we do not limit borrowers on the bridge loan size as long as the borrower’s home has the equity. Also, we can close on the bridge loan in less than 2 weeks. First Heritage’s bridge loan is a great solution to overcome the issue of timing or a non-contingent offer.

However, it’s not free and costs about 1.00 points, and in some cases 1.5%. For example, if a borrower’s loan size is $500,000 for their bridge loan, then 1.00 points would cost $5,000 in a one-time fee to close on the bridge loan. Instead of paying this fee and having to react so quickly, can you guess what the better solution is? Obtain a HELOC in advance, it’s one of the best financial moves you’ll ever make in real estate. Additionally, there are no closing costs to obtain a HELOC!

If after reading this article you are ready to move forward with a HELOC, then below are two important factors to consider:

• Make sure you have equity. For example, if your home is worth $1,000,000 at the best rates (6.750%-7.250%), your total loan amounts combined (current mortgage and HELOC) cannot exceed 80% of the value of the home or $800,000.
• The home used for a HELOC cannot be a rental property.

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