Be prepared, because things have changed a lot. You may be able to pay less for yourÂ second mortgageÂ with a home equity line of credit (HELOC) refinance or new home equity loan (HELOAN).
The HELOC has a drawing period, in which it functions a lot like a credit card. Your minimum payment is interest-only, and based on your current balance and interest rate.
The HELOAN usually carries a fixed rate. It delivers a lump sum at closing, and you repay the loan in equal monthly installments.Click to see today's rates (Sep 24th, 2017)
What happens with some HELOC borrowers is that they max out their credit lines during the drawing period and just make the minimum payment. But when the drawing period ends, the entire balance must be repaid over the remaining term of the loan.
If you have a 15-year HELOC, your drawing period might be five years, and then you have ten years to pay off the entire balance. If you have a 25-year HELOC, your drawing period might be ten years, and once that ends, you get 15 years to repay theÂ balance.
Making things worse, HELOCs almost always come with variable rates. And lately, interest rates have been heading higher.
If you can pay down your loan balance quickly, that's a great way to avoid a payment spike and extra interest charges. But not everyone can do this. Fortunately, you probably have additional choices:
Determine your goal for refinancing. Reducing current mortgage payments, lowering your interest rate, or getting access to new fundsÂ are all valid goals. Each has its pros and cons.
Whatever refinancing you choose, it could provide more liquidity and some financial relief. However, stretching out the repayment of a loan balance can increase your overall interest expense, even if your new rate is lower.
HELOC refinanceÂ requirementsÂ are more stringent than they were ten years ago. So, you may haveÂ to meet guidelinesÂ that didn't existÂ when you took out your loan.
Today, lenders must determine your ability to repay (The ATR Rule) beforeÂ approving a HELOC refinance. Youâ€™ll probably have to provide moreÂ documentation to qualify for a new mortgage as well.
In most cases, you must have at least 20 percent equity in your homeÂ to refinance,Â although highly-qualified borrowers can find HELOCs and HELOANs of up to 90 percent of their property value.
Knowing your financial position helpsÂ you choose the best way to refinance your HELOC. Personal economic factorsÂ determine if it makes sense to combine your first mortgage and HELOC into a new loan, or just refinance the HELOC.
Keep in mind that closing costs are usually lowest for a HELOC and higher for a HELOAN. RefinancingÂ both of your loans into a new first mortgageÂ may get you the lowest interest rate, but often comes with higher closing costs.
This is partly because these loans are usually considered cash-out refinances, which lenders consider riskier than standard rate-and-term refis.
To see if it makes sense to combine your loans, compare the "blended rate," a weighted average of the first mortgage and a new HELOC or HELOAN, with the interest rate for a new cash-out refinance.
A blended rate tells you the overall interest rate you're paying on thee total of several accounts with different amounts and / or interest rates.
For instance, if you paid 4.0 percent interest on a $50,000 loan, and 5.0 percent on another $50,000 loan, your blended rate is 4.5 percent.
Here's how the calculations look:
|Loan A||Loan B|
|Loan Amount||Â $50,000||Â $50,000|
|Total of All Loans||Â $100,000|
|Percent of Total||50.0%||50.0%|
|Rate * Percent of Total||2.0%||2.5%|
|Total of all Weighted Rates||4.5%|
Usually, though, a HELOC balance in considerably lower than that of the first mortgage. It's not an easy 50/50 deal. But the calculations are the same.
|First Mortgage||HELOC Balance|
|Loan Amount||Â $275,000||Â $25,000|
|Total of All Loans||Â $300,000|
|Percent of Total||91.7%||8.3%|
|Rate * Percent of Total||3.67%||0.63%|
|Total of all Weighted Rates||4.29%|
If you can't find a refinance mortgage wrapping both loans into a new one at a better rate than 4.29 percent, you might want to scrap any consolidation plans. If it's cheaper and makes sense, you may refinanceÂ your first and second mortgages separately, or just keep your current first mortgage and replace your HELOC.
If, however, your HELOC balance is relatively large, a cash-out refinance might be a great solution. In this case, the borrower plans to keep the property for five more years, and is looking at rates for 5/1 ARMs.
So, if the blended rate turns out to be less than 3.0 percent available for 5/1 mortgages, combining the first mortgage and HELOC into a new loan makes sense. In this case, the blended rate is an expensive 5.48 percent.
|First Mortgage||HELOC Balance|
|Loan Amount||Â $85,000||Â $50,000|
|Total of All Loans||Â $135,000||Â $|
|Percent of Total||63.0%||37.0%|
|Rate * Percent of Total||2.52%||2.96%|
|Total of all Weighted Rates||5.48%|
Getting a new HELOC, if your finances make it possible, would reset your entire mortgage loan to the draw period. That gives you an entire new term to repay the loan.
However, you'll probably have a variableÂ interest rate, which can make budgeting a challenge.Â As the Fed raises interest rates, the bank raises your HELOC rate.
A new HELOANÂ almost always carries a fixed interest rate. However, the fixed rate is higher than the variable rate of a HELOC, and your closing costs will probably be higher.
Lenders consider two mortgages taken out at different times then combined into one mortgage a â€ścash out refinance.â€ť
You can get a cash-out refinance up toÂ 80 percent of your property value under most conventional (non-government) mortgage programs.
FHA allows cash-out up to 85 percent, and doesn't add extra charges for cash out. However, the mortgage insurance can be steep.
VA home loans for military households allow cash out up to 100 percent of the property value if you're eligible.
If you have enough home equity, you may be able to refinance your first mortgage and HELOC, plus pull additional cash out of the property.
Avoid this loan type if it doesnâ€™t fit your financial objectives.
HELOCs and HELOANs are also called "second mortgages" because their liens are "junior" to the lien held by the lender with the first mortgage.
What that means is if you lose your home to foreclosure, the lender with the first mortgage gets paid first out of any auction proceeds.Â The junior lien-holder only gets repaid if there is enough money left over.
If you decide to refinance a first mortgage separately from your HELOC, you may have some title issues. The holder of the second mortgage must agree to "subordinate" its lien to that of the new first mortgage lender.
That's because once the old first mortgage is repaid, the HELOC automatically moves into first position. Naturally, the new first mortgage lender won't be willing to take on the risk of being in second position.
The only way this transaction can happen is if the HELOC lender agrees to drop into second position once the new first mortgage closes.
If this is your refinancing plan, start the re-subordination process early and work to get juniorâ€™s cooperation.
Current refinance rates are slightly lower than they were last week. However, rates for first mortgages, home equity loansÂ and HELOCs move constantly as economic conditions change.Click to see today's rates (Sep 24th, 2017)
The information contained on The Mortgage Reports website is for informational purposes only and is not an advertisement for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent, or affiliates.
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