Home Equity Line of Credit (HELOC)
A HELOC is an adjustable rate home loan that you can access a lot like a credit card. It has a credit limit that you can draw from and pay down over a set draw period, typically 10 or 20 years. Your payment is based on your balance each month.
Some HELOCs require you to pay only the interest due on the outstanding balance, which means you’re not paying the balance down, and some require a principal and interest payment, which means your payment will be higher, but you’re paying the balance down.
A HELOC is often a second mortgage behind your primary first mortgage, but it doesn’t have to be. If you had no first mortgage, you could put a HELOC in place as your only loan.
Most HELOCs qualify you buy using a payment that’s significantly higher than you’d actually be required to make. They do this because HELOC rates are adjustable, and lenders want to account for rates (and therefore payments) moving higher in the future.
Most HELOCs also have a “fixed-rate draw” or a “fixed-rate advance” option which allows you to draw a portion of the HELOC balance at a fixed rate. This will protect you from future rising rate risk, but rates for fixed-rate draw are usually higher than the HELOC rates at the time of the fixed-rate draw.
HELOC rates are determined by adding the Prime Rate to a base rate called a margin. The Prime Rate can move as the Fed adjusts rates each year. Your margin is based on your credit score and how much equity you have in your home.
Home Equity Loan
What it is:
A home equity loan is simpler than a HELOC in that it’s just a lump sum loan. It’s a second mortgage that goes in second lien position behind a first mortgage. This is different than a HELOC that could be your one and only mortgage, because if you owned your home outright and needed cash in a lump sum, you’d get a cash out refinance and it would just be a first mortgage.
Comparing home equity loan vs. HELOC rates, a home equity loan rate will typically be higher because it’s a fixed-rate loan, whereas a HELOC is adjustable.
Comparing a home equity loan vs. a cash out refinance, a home equity loan rate will typically be higher because it’s a second mortgage, whereas a cash out refinance is a first mortgage.
Home equity loans are typically fixed for 20 or 30 years, and they qualify you with their fully amortized payment.
Cash Out Refinance
A cash out refinance is a first mortgage that allows you to take cash out of your home. If you own your home outright, the entire balance of a cash out refinance (minus closing costs) would be net proceeds to you. If you had a loan balance on your home from purchasing it using a loan, a cash out refinance would be a new loan for greater than the existing balance, and the difference between the existing balance and the new balance would be net proceeds to you.
Comparing a cash out refinance vs. HELOC, cash out refinance rates will be lower because it’s a first mortgage.
Comparing a cash out refinance vs. refinance, traditional refinance rates will be lower because there is a rate premium for taking cash out.
Cash out refinances can be fixed or adjustable rates. Fixed rates qualify using the payment. Adjustable rates will often qualify using a payment that’s higher than you’d actually be required to make because they need to account for the fact that rates will move higher in the future.
If you’ve had a HELOC or a home equity loan as a second mortgage in the past, you can combine that second mortgage with a new cash out refinance first mortgage to consolidate all your debt into one single loan. Ask your lender to present options to you, because it will depend on how much equity you have.