SFMortgage.com Smart Financing The Insider’s Guide

Tapping the equity in your home should be done thoughtfully and as part of an overall financial plan.

  1. Familiarize yourself with the two loan types.
  2. Carefully consider your needs.
  3. Pose any tax-related questions to a CPA or
    tax advisor.
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What about a home equity line of credit, or a home equity loan?

You can tap the equity in your home by using a home equity line of credit (HELOC) or a home equity loan (HELOAN). These loans generally require less paperwork and time than a refinance of your primary mortgage, and have little or no closing costs. HELOC/HELOANs are also frequently used in combination with a first mortgage when a borrower is purchasing a home and putting down less than 20%.

Both HELOCs and HELOANs are priced primarily using the borrower’s credit score and the property’s loan-to-value. Getting a credit approval for one of these loans for an amount up to $1,000,000—subject to an appraisal and verification of information in the application—will generally take less than 24 hours.

What is the difference between a HELOC and a HELOAN?

  • The HELOAN has a fixed interest rate and fully amortizing payments that include principal and interest; the HELOC has an interest-only payment option and is keyed to the prime rate and always adjusts monthly whenever the prime rate moves, with one exception that will be addressed below.
  • The full amount of the HELOAN must be taken at close of escrow; with the HELOC, you have the option of using as much, or as little, of the available credit as you choose.
  • With the HELOC you have a great deal of flexibility. If you pay down a portion of the HELOC your payment will drop proportionately. If you choose to run the line back up later you may. Paying down a portion of the HELOAN will not change the payment, and once a portion has been paid down, you can not run the balance back up again like you can with a HELOC.
  • The fixed interest rate on the HELOAN will usually be .50% to 1.00% lower than the adjustable interest rate on the HELOC. However, the interest-only payment on the HELOC will be lower than the fully amortizing payment on the HELOAN, even though the HELOC interest rate is higher.
  • The most recent innovation in real estate finance is a HELOC that allows for a fixed interest rate for a portion of the line amount that has been used, while the unused balance of the credit line will have an adjustable rate when you use it in the future.

When is a HELOC a better choice?

  • If you want a resource you can tap at any time: this is important because you only pay for the money you are using. The interest only option keeps the payments low.
  • If you want flexibility: you can pay the HELOC down in chunks, all the way to zero, and lower the payment proportionately, and then run the line back up again if you have a use for the money.
  • If you are less concerned about having an adjustable rate and a changing payment.
  • If you are able to pay your credit line down in large chunks—through bonuses, a refinance after doing extensive remodeling, the sale of a piece of property, or a liquidity event.

There is a new product in the marketplace, a HELOC that allows you to lock in at any time a fixed interest rate for all or part of the amount of the HELOC that you have used. If you are getting a HELOC, ask if you can have the option of fixing the interest rate for a portion of the line amount in the future. This can be a very valuable option if interest rates begin to rise, and combines the best features of both the HELOC and the HELOAN.

When is a HELOAN a better choice?

  • If you are more financially conservative and want a predictable monthly payment and a fixed interest rate, and you can afford the higher monthly payment.
  • If you need a particular sum of money at one time, and are fairly certain that you will need to pay it back gradually over a long period of time.

Is the interest on a HELOC or HELOAN tax deductible?

The interest on second mortgages, when used for a primary residence or second home, may be tax deductible, subject to the standard IRS limits on the deductibility of home mortgage interest.

Whenever you have tax questions related to real estate finance, we recommend that you speak to a CPA or financial advisor who is familiar with your particular situation and state and federal tax law.

How can a HELOC or HELOAN be used in a purchase transaction?

When you are purchasing a home and putting down less than 20%, and you are getting a non-conforming (jumbo) loan, most lenders will require that you have a HELOC or a HELOAN for any amount financed in excess of 80% of the purchase price. For conforming loans the lenders will make loans in excess of 80% of the purchase price but will require mortgage insurance; a HELOC or HELOAN for the amount over 80% loan-to-value eliminates the need for that insurance, and the interest on the HELOC or HELOAN is usually tax-deductible, while the mortgage insurance is not, unless your income is less than $100,000 a year.