You may have heard of a home equity line of credit (HELOC). It helps homeowners convert their valuable home equity into a line of credit they can use for anything – from home improvements to debt consolidation to big-ticket item purchases. A HELOC is also known as a second mortgage. But when it’s a first-lien HELOC, it jumps ahead of other loans secured by your property and sits in the first loan or first-lien position.
With a first-lien HELOC, there is no second mortgage. Your line of credit and home loan combine into a single loan. This is a financial tool that can simplify your finances because there’s only one monthly payment.
But despite its advantages, homeowners should carefully weigh the drawbacks of a first-lien HELOC. Let’s look at the pros and cons of a first-lien HELOC to help you determine whether it’s the right option for you.
What Is A First-Lien HELOC?
A first-lien HELOC, sometimes called a first-position HELOC, is a type of all-in-one home financing that bundles your mortgage and HELOC as first-lien debt.
A lien on a home is a claim that gives an individual or entity the right to reclaim the property if a borrower can’t repay the loan. If a home carries multiple mortgages, that means the home has multiple liens on it. Typically, a mortgage loan sits in the first-lien position. If the borrower defaults or forecloses on their loan, the first-lien debt holder (in this case, the mortgage lender) gets paid before all other debt holders – except tax authorities.
A HELOC is usually in the second-lien position, making it a second mortgage. In case of a default or foreclosure, it’s only paid off after the first lien is satisfied. A first-lien HELOC – which merges with a mortgage to become a single debt – sits in the first loan position, prioritizing that lender over other lenders for loan repayment.
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How Does A First-Position HELOC Work?
HELOCs work as a revolving line of credit. During its first phase, the draw period, you use it like a credit card, withdrawing funds whenever you want up to its credit limit. It can be used to pay off your remaining mortgage balance. And once the draw period ends, the line of credit will enter its second phase, the repayment period. During this phase, you’ll make monthly payments that cover principal and interest, like an installment loan.
For example, let’s say you have a traditional 30-year fixed-rate mortgage you’ve been paying faithfully for 25 years. You can use a first-lien HELOC to pay off the remaining balance on your mortgage, making the line of credit your new mortgage or first lien. Even if you’ve paid off your mortgage and own your home outright, you can still get a first-lien HELOC.
Either way, you’ll have a line of credit you can draw from as necessary and repay the borrowed funds. This kind of flexibility can come in handy if you need to make ongoing home improvements and pay several contractors, have a child’s college expenses to pay for or have high-interest debts you’d like to consolidate.
Pros And Cons Of First-Lien HELOCs
Weigh the pros and cons before you decide to use a first-lien HELOC.
Pros
A first-position HELOC can offer these advantages:
- Greater spending flexibility: During its draw period, homeowners make interest-only payments on the amounts withdrawn.
- Numerous repayment options: HELOC repayment terms can offer greater flexibility by allowing borrowers to customize financing around their needs and budget.
- Favorable interest rates: Homeowners with high-interest mortgages may be able to secure a HELOC at a lower interest rate. Because this loan type is secured by a home, they usually have more competitive interest rates than unsecured options.
Cons
A first-position home equity line of credit may present these disadvantages:
- Risk of foreclosure: A HELOC is a secured line of credit. The collateral that secures the HELOC is your home. A borrower risks foreclosure if they fall behind on repaying their outstanding balance.
- Variable interest rates: Most HELOCs have variable interest rates, making it difficult to predict monthly payments as market rates rise and fall.
- Closing costs: HELOC closing costs range from 2% – 5% of the total amount borrowed. This type of financing can get expensive if you need a substantial amount to pay off your existing mortgage.
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Alternatives To First-Lien HELOCs
A first-lien HELOC is a convenient way for homeowners to take advantage of their home equity and combine the line of credit with their mortgage, but some risks are involved.
To help steer clear of the risks, talk to a financial advisor and consider alternative loans.
Luckily, homeowners have a few options to dip into their equity. Or they can take out a loan to fund home improvements or cover expenses.
Personal Loan
A personal loan doesn’t put another lien on your home because personal loans are unsecured and don’t require any collateral to secure the loan. However, because personal loans are unsecured, they usually have higher rates.
Most personal loans are best for smaller cash amounts. They’re typically suitable for consolidating a handful of small debts or making an expensive purchase, like a car or motorcycle. Some personal loans have origination fees. They typically range from 1% – 10% of the total loan amount.
Many banks, credit unions and online lenders offer personal loans.
Cash-Out Refinance
Another option is a cash-out refinance. Also known as a cash-out refi, it’s a type of mortgage refinance that allows homeowners to tap into their equity to replace their existing mortgage with a bigger loan and then pocket the difference between the new loan and the old loan in cash.
A cash-out refinance may be a better option for homeowners who don’t want to put another lien on their property and want to change their monthly payment or modify their repayment terms.
Home Equity Loan
A home equity loan is another option homeowners can use to borrow against their equity. The home equity loan is a second mortgage secured by the home and paid separately from your primary mortgage.
When a homeowner takes out a home equity loan, they receive a lump sum of money they repay in installments over a fixed term, usually between 5 and 30 years. The interest rate is usually fixed, so your monthly payments stay the same over the life of the loan.
FAQ
We’ve collected the most frequently asked questions about first-lien HELOCs.
The Bottom Line
First-lien HELOCs share many similarities with standard HELOCs, except they sit in the first-lien position because they replace the existing primary mortgage. They also offer homeowners advantages, like flexible loan terms and competitive interest rates. To help avoid the potential risks of this type of financing, talk to a financial advisor about your situation before you make a decision.
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Josephine Nesbit
Josephine Nesbit is a freelance writer covering real estate and personal finance topics, including home loans, homeownership, real estate investing, building credit, and paying down debt. She attended The Ohio State University and has been published in Fox Business, GOBankingRates, U.S. News & World Report and Bankrate.
