Fixed Rate Second Mortgages vs. HELOC
Does it make more sense to get a fixed rate second as opposed to a Home Equity Line of Credit?
Life is about choices. When you need money to pay off your debts and decide to use your home as collateral, you can either take out a fixed-rate second mortgage or apply for a Home Equity Line of Credit (“HELOC”). Which one should you go for?
The answer will depend on many factors. The nature of your needs is certainly the principal factor.
If you need money for one lump-sum payment, like when you add an extension to your house or repair the roof, you may want to think about a fixed-rate second mortgage (to which we'll refer to “fixed-second” from now on).
If, however, you'll need money for recurring charges over a certain period of time, like when you are paying your son's or daughter's college tuition, then a HELOC might be the better alternative.
The fixed-second comes with a fixed interest rate and its maturation date varies between 15 to 30 years. The whole amount is delivered to your account in the beginning of the loan. You pay it back over the lifetime of the loan by making fixed monthly payments. In that sense, a fixed-second is similar to the first mortgage except it is represented by a second lien on your property. The best part of the fixed-second is payment predictability.
A HELOC, on the other hand, works just like a credit card. No lump sum is delivered when your HELOC account is set up and becomes active. You withdraw against your loan limit when you need to and then pay it back. However, since it is backed up by your home, you can lose your home if you fail to pay your line of credit.
A HELOC or fixed-second limit is calculated by subtracting your loan-to-value (LTV) from your cumulative-loan-to-value (CLTV). This is because a HELOC or fixed-second loan limit is governed by your CLTV. For example, take 75% of your home's current appraised value as a base for your loan amount. Assume further that your home's appraised value is $300,000. How much will your HELOC or fixed-second be?
75% of your home's appraised value of $300,000, yields $225,000. You then subtract the amount you still owe on your first mortgage from that amount. Let's say you financed $150,000 to purchase your house and you still owe $75,000. The $75,000 you still owe is subtracted from $225,000, leaving you with your HELOC or fixed-second loan limit of $150,000.
Unlike a fixed-second, a HELOC has a complicated structure that may vary from lender to lender. Some, for example, require you to withdraw a minimum amount only and nothing less. Some will tag you with withdrawal or other account fees while others do not. Setting up a HELOC does cost a little bit more than setting up a fixed-second.
A HELOC does not come with a fixed maturation date. However most such line of credits have a “draw period” (typically 10 years) and a “repayment period” (again typically 10 years). During the repayment period the borrower is not allowed to draw anything out of a HELOC account, at the end of which he is expected to pay off completely all outstanding HELOC balances or lose his home.
Just like a regular mortgage, a HELOC has tax advantages as well. Since it is secured by real estate, you may be allowed to deduct the interest you pay on your HELOC debt.
The crucial thing to remember is that a HELOC has an adjustable rate of interest that is based on a publicly announced index, like the prime rate. A HELOC’s interest rate is usually an amount that is tacked on top of the index, as in “prime plus two percent.” Thus when the index fluctuates, so does the interest you pay on HELOC debt. So you need to decide whether a fixed-rate second makes more sense than a HELOC.
Better yet, why don't you just give us a call TODAY at (877) 310-FUND for a free and confidential consultation on whether a fixed-second or a HELOC is better for your situation? We know all about indexes and interest rates and we'll shop around for you to make sure that you get the best financing you need for your specific purposes.
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