HELOC FAQs
Home Equity Lines, Home Equity Loans, Second Mortgage

by Nancy Osborne, COO of ERATE®

What is the difference between a traditional second mortgage and a home equity line of credit?
Both traditional seconds as well as home equity lines of credit are technically considered second mortgages. With a traditional second mortgage, the rate is typically fixed and all funds are paid out at closing. The term of the mortgage could be anywhere from 15 to 30 years. With a Home Equity line of credit, as the name implies, the funds are drawn from a credit line account as needed and not paid out in a lump sum at closing. The rate on the credit line is typically an adjustable (usually tied to the prime rate index) and the term can be anywhere from 15 to 30 years. Home equity lines have a draw period, typically occurring in the first 10-15 years, with the remaining term on the loan referred to as the repayment period.

Is it better to refinance my first mortgage to take cash out rather than getting a second mortgage on my property?
First determine how competitive your existing first mortgage rate is relative to where current interest rates are. Also, evaluate how many years you have paid into your existing first mortgage. For example, if you have been making payments for only several years and today's market rates are close to where the rate on your existing first mortgage is, then you may want to consider refinancing your first. Conversely, if the rate on your existing first mortgage is substantially lower than that of current market rates and if you have been making payments on your mortgage for a period of five years or more, then a second mortgage may be a more sensible financial solution than starting over with a new first loan. Consultant with your financial advisor for an optimal decision. Today's home equity loan rates.

How do I determine which type of secondary home equity financing is best for me?
A reasonable guide for making this decision is to evaluate your intended use for the funds. If you have a pre-determined expense that will require a lump sum or fixed payment (i.e. major home improvements for which you have a written estimate) then you may prefer a traditional second mortgage with rate and term that are fixed for the life of the loan. Conversely, if you have a stream of undetermined expenses (i.e. misc. home improvements, misc. consumer purchases) then you may prefer the check writing convenience of a home equity line. With a home equity line of credit, you pay interest only on the funds you use or need, therefore with unforeseen expenses this may be the most cost-effective approach.

What documentation will the lender normally require from me to process my loan?
The amount of home equity you have in your property will in large part determine the answer to this question; the greater the amount of Home Equity, the lower the documentation requirements. Also consider the tendency of lenders to provide lower interest rates for borrowers willing to document their income. Most lenders will require at least a current paystub and W-2's (1040's will be requested of the self-employed) yet others may request no documentation at all. But, if a lender is offering a knockout rate and terms, then a complete loan package may be warranted.

Are limited documentation (aka EZ doc, no income qualifier) loans available?
Yes, it is possible to get a second mortgage without documenting your income. Most lenders will require that you have approximately 20% equity in your property (after closing on the second mortgage) and the rate typically will not be as favorable as when income documentation is provided.

Can I apply for a second mortgage secured against an investment or rental property?
Yes, it is possible to get a traditional second mortgage or a home equity line of credit on a property that is non-owner occupied. Most lenders will require that you maintain at least 20% equity in the property (after closing on the second mortgage), and there may be a loan maximum which is lower than that of owner occupied loans. Additionally, the request for qualifying documentation from a borrower may be higher than that of owner occupied loans.

Will an appraisal of my property be required when I apply (even if I've had my property appraised within the last year)?
Yes, the property is the collateral for the loan and therefore some type of appraisal will be performed. Although how extensive an appraisal required can vary from one lender to another and could depend on the amount of equity in the property at closing. Some lenders may request a simple in house "computer appraisal" (a computer search of recent comparable sales in the neighborhood), others may request that a complete appraisal be performed by a fee appraiser. Generally an appraisal is valid for a period of 90 to 120 days.

Refinance at Today's Low Rates!

What is the maximum I can borrow on a home equity line?
There are lenders who will loan as much as $500,000 on a home equity line, assuming that a property has sufficient equity. Also available are home equity lines up to 125% of a property's value (however, please consult with your tax advisor prior to entering into this type of non-traditional financing).

Once my home equity line has closed, what if I find I needed a bigger loan?
Unless your personal banker has provided your home equity line, it is likely that you will need to re-apply for a loan if you plan to exceed the maximum terms of the existing loan agreement. However, this process could be streamlined if the lender already has much of your documentation on file.

What are the typical terms of a home equity line of credit?
The typical home equity line is tied to the prime rate index which is added to a fixed margin (determined by both a borrower's equity and credit). A home equity borrower is provided with a credit account that is applied against their home equity (typical credit lines range from $50,000-$200,000) from which they will have check writing privileges. The loan term is usually between 15 to 25 years; the draw period occurring within the initial 10 to 15 years and the repayment period occurring in the remaining loan term. The borrower pays interest only on money that is borrowed (drawn against the account) and not on the unused balance on the home equity line. Therefore the loan balance of a home equity line fluctuates based upon the periodic draws and repayments on the account. Also see Anatomy of an Adjustable Rate appearing on our website.

 

What are the typical terms of a traditional second mortgage?
A traditional second mortgage has a fixed rate of interest with equal monthly payments applied over the life of the loan. The rate of interest is determined by a borrower's equity and credit and is usually a few percentage points higher than rates on first mortgages. The typical loan term typically ranges between 15 to 30 years.

 

What is the average repayment period on a home equity line of credit?
The average repayment period ranges between 15 to 25 years for home equity line financing. However both shorter and longer term loans are available.

 

How do I determine which loan program is best suited for my personal situation?
Please see Guidelines for Selecting a Loan on our website.

 

What type of closing costs are associated with second mortgages?
For second mortgages which are not available at no cost, the following fees may apply. The title and escrow fees are dramatically reduced from that of first mortgages. For many second loans up to $200,000, most lenders will permit what is referred to as a "flag" title insurance policy which has an associated flat fee of $125. A "sub-escrow" or "mini-escrow" fee is also charged and ranges between $225-$250. Also charged are standard notary, recording and payoff fees ranging from $60-$150. Additionally lenders charge their own loan administrative fees which generally cost about $250. If a fee appraisal is required, that could cost between $300-$400 for a standard owner occupied single family tract home. Credit fees charged will run between $25-65.

 

Can I get a no cost home equity line?
Yes, many lenders offer home equity lines at no cost. Depending upon borrower equity and credit, these loans may carry higher interest charges. Be careful in comparing a no cost loan to one with fees, making certain that you are performing an "apples-to-apples" analysis of rates and terms.

 

Do home equity lines typically have prepayment penalties?
Yes, many home equity lines available today do have prepayment penalties. However most penalties apply only if the home equity line is both paid off and the account is closed to further cash draws or advances. Therefore, if the home equity line is paid down to a zero balance, but is left open to future draws against the account, the penalty would not apply. In those instances where a home equity line borrower chooses to both pay off and close the account, the prepayment penalty normally imposed amounts to about $500.

 

Can I use the proceeds of the home equity loan for any purpose I choose, such as the purchase of an automobile?
Typically the funds can be used for any purpose a borrower chooses. Please see our link to the IRS website, also consult with your tax professional.

 

Are the interest payments on my home equity loan tax-deductible?
Please see our link to the IRS website, also consult with your tax professional.

 

How can I find a qualified, reputable CPA to advise me?
There are always the "big five" accounting firms to rely on and referrals from family and friends are also advisable. Helpful on-line resources for finding service providers in your area is www.cpalink.com.

 

When making improvements to my home, is it wise to first consult with my real estate agent?
In a buyer's market (many sellers, too few buyers) a homeowner should be particularly careful to avoid making improvements to their property that cannot be recouped or recovered at sale. The best way to prevent making an over improvement to a property is to consult with your local real estate agent to be certain that your investment in improving your home is commensurate with what other homeowner's in your area are doing. This way you can avoid making improvements that you will not be reimbursed for if and when you decide to sell.

In a seller's market (many buyers, too few sellers) excessive over improvements could be viewed as advantageous and the risk of non-recovery reduced. There are also homeowners who want to improve their property only for their own comfort and pleasure and are not concerned with recouping this added investment when they do sell it.

When making improvements to my home, how do I find a qualified, reputable architect?
There are always referrals from family and friends to rely upon. Helpful on-line resources for finding service providers in your area are HomeAdvisor and www.americanarchitecture.com.

When making improvements to my home, how do I find a qualified, reputable contractor?
There are always referrals from family and friends to rely upon. Helpful on-line resources for finding service providers in your area are HomeAdvisor and www.americanarchitecture.com.

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Nancy Osborne has had experience in the mortgage business for over 20 years and is a founder of both ERATE, where she is currently the COO and Progressive Capital Funding, where she served as President. She has held real estate licenses in several states and has received both the national Certified Mortgage Consultant and Certified Residential Mortgage Specialist designations. Ms. Osborne is also a primary contributing writer and content developer for ERATE.

"I am addicted to Bloomberg TV" says Nancy.