You probably heard about HELOC or second mortgage, but few people know they can take something that is called a first lien HELOC. So what are HELOC and first-lien HELOC, and what are the main differences?
What is a first lien HELOC? A first-lien HELOC is similar to a home equity line of credit (HELOC) or second mortgage. Only, with first-lien HELOC, you are putting HELOC in the first lien position, replacing your mortgage with HELOC.
First lien HELOC combines credit and mortgage in one, and it has become more and more popular among modern homeowners who wish to pay off their mortgages faster and without much hassle. Let’s find out more about this.
A first-lien HELOC works like a line of credit and mortgage in one. With first-lien HELOC, you will basically replace your existing mortgage by refinancing it.
The first line HELOC also works like an ordinary line of credit or checking account. Meaning you will have money at your disposal to spend on whatever you want.
What is important to explain is that with first-lien HELOC, you will pay only monthly interest on the balance, while if your HELOC is in second place, you will pay that as well as your monthly mortgage payments.
Second-lien HELOC is what people refer to when talking about the Home Equity Line of credit. HELOC is usually called a second mortgage, even though it is not a mortgage.
It looks more like regular credit where you put your home equity as collateral. Once you are approved for a mortgage, a monthly payment will be calculated, and if you take HELOC, these payments will remain on top of the new obligations you will have with HELOC.
But if you refinance your mortgage and replace it with first-lien HELOC, you will only have to pay that. Also, we should mention that the first-line HELOC is excellent if you wish to pay off your mortgage faster.
By putting your HELOC in the first lien, you will reduce the risk of default. Another big difference between second and first-lien HELOC is the amount you will be able to get.
For example, if your home is worth $300,000 and you paid $100,000, it means your equity is $200,000. But the bank will give you 80% financing of the value of $240,000, which leads us to a $40,000 HELOC.
While the amount is larger with first-lien HELOC, it looks something like this.
Second Lien HELOC:
- Home value: $300,000
- $300,000×80% = $240,000
- Amount owed $200,000
- $240,000-$200,000 = $40,000 of HELOC
First lien HELOC:
- Home value: $300,000
- Mortgage balance: $200,000
- $300,000×80% = $240,000
- You will get HELOC balance of $200,000
- Line of credit of $40,000
The process of getting a first lien HELOC is exactly the same as getting a refinance of your mortgage. You will have an appraisal of the home, FICO check-up, income, and financial checkups, as well as your debt to income ratio so the lender can see if you are able to pay for this credit.
Here are the criteria you will meet to get HELOC:
- A certain percentage of equity in your home,
- Good credit (680 or more),
- Low debt-to-income ratio (DTI),
- Sufficient income,
- Reliable payment history.
As you know, there is something called a Home Equity Loan, and it’s usually confused with a HELOC. And even though there are some similarities, there are much more differences.
For starters, HELOC is more flexible and you have an amount you can spend for a longer period until the draw period is over. Here are the main differences between Home Equity Loan and HELOC.
|Home Equity Loan||HELOC|
|You will get lump-sum amount at once||Revolving credit line for a pre-approved amount|
|Fixed monthly payments||interest-only payments|
|Fixed interest rates||Adjustable mortgage rates|
Is Cash-Out Refinance a Better Option?
If you wish to get to a certain amount of money, there is a third option you can use. It is called a cash-out refinance, and it’s something your mortgage broker can advise you on and fix you up with the best deal.
So how does cash-out work? With cash-out refinance, you will write off your mortgage by taking another one for a higher rate. You will basically then take that new mortgage to pay off the old one and keep the difference.
That only pays off if you have significant equity in your home. This difference will be available for your expenditure in a lump sum.
As we mentioned earlier, putting a first lien HELOC is much safer than taking regular HELOC. This type of refinancing is great because it allows you to pay your principal sooner.
Still, it is not a good option if you are not certain you will have significant cash flow and income. With HELOC, you will have adjustable rates that can be unpredictable.
On the other hand, if you wish to have a house, pay your mortgage, and have access to a certain amount of cash, this is way better than taking regular credit cards because you will pay less interest with HELOC.