Home equity lines of credit (HELOCs) are typically adjustable rate mortgages in subordinate position behind first mortgages. Because their secondary lien position holds disproportionate risk (they are the last to get paid back in the event of a foreclosure) the standing of the first mortgage is enhanced, thereby improving one’s overall financing.
A once common tool, HELOCs largely vanished from the marketplace in the midst of the housing crisis. Of the limited pool of HELOCs offered over the past few years, most have been limited to covering just 60 to 70 percent of a property’s value. Since favorable first mortgages are routinely offered to 80 percent consideration, these equity lines have been of limited utility. Fortunately, we are now seeing equity lines of credit that will cover up to 90 percent of a property’s purchase price. This is perhaps the strongest indicator of growing investor confidence in the housing industry.
Here are four ways that an equity line might be used to improve one’s mortgage financing on a transaction:
Avoid Mortgage Insurance
Any mortgage with financing in excess of 80 percent of a property’s value will carry mortgage insurance. This cost can be built into the note rate as "lender paid" insurance, or presented as a separate monthly payment in the form of "borrower paid" insurance. Either way, the cost is real and can be substantial. If a buyer were a bit short of 20 percent down payment funds for a desired property, a small equity line of credit could bridge the gap and dispense with the need for mortgage insurance.
Increase Purchase Power
Some loan products do not allow for financing beyond 80 percent, whether mortgage insurance is available or not. As an example, let’s look at a buyer whose income qualifies them to purchase a home in the $800,000 range. But if they have only $80,000, or 10 percent down payment funds, they will likely be unable to secure a first mortgage with 90 percent financing. With an $80,000 equity line, they could finance the gap and close on their new home.
Get A Better Loan Product
Let’s use the example listed above, but this time with a buyer who has the preferred 20 percent down payment. With $160,000 against the $800,000 purchase price, they would be left with a $640,000 non-conforming jumbo loan. An equity line of $14,500 would enable them to secure a conforming loan of $625,500 with a preferred interest rate of between ½ to ¾ percent lower than the jumbo product's and potentially save them more than $150,000 in interest payments.
As A Bridge For Bonus Income
For borrowers expecting significant bonus income and whose goal is to secure low, fixed payments, an equity line of credit might be the perfect tool. Let’s take the example of a lawyer buying a million dollar property with a 75 percent down payment of $250,000. If getting a $750,000 loan, the 30-year fixed mortgage payment would be around $3900 at today's pricing. While this is still well-priced money, our lawyer is expecting a large bonus and would like to buy down his/her mortgage. Although this would help to pay off the mortgage sooner, the amortized payments on the jumbo loan would remain fixed. But, if instead the purchase was made with a $450,000 first mortgage and a $350,000 equity line of credit, the equity could be paid off with bonus money, and the borrowers would be left with a first mortgage $1800 monthly payment.