What Is A First-Lien HELOC And Is It Right For You?
You may have heard of a home equity line of credit (HELOC), which helps homeowners turn their valuable equity into a line of credit they can use for anything – from home improvements, debt consolidation or paying for other expenses. A HELOC is also known as a second mortgage but it can be written in the first-lien position. This means there is no second mortgage and your HELOC and mortgage are packaged as one.
Known as a first-lien HELOC, this financial tool allows you to only have one home loan to worry about with the added advantage of having access to all of your equity. However, this type of loan isn't for everyone and there are significant risks associated with it.
At this time, Rocket Mortgage® does not offer HELOCs.
What Is A First-Lien HELOC?
A first-lien HELOC, sometimes called a first-position HELOC, combines your mortgage and the HELOC as first-lien debt. Typically, the primary mortgage lien sits in the first-lien position. If you default on the loan, first-lien debt holders, which would be the mortgage lender, are paid back before all other debt holders – except tax authorities.
How Does A First-Lien HELOC Work?
Let’s say you have a traditional 30-year, fixed-rate mortgage that you’ve been paying faithfully for 25 years. If you get a HELOC, you could use it to pay off your 30-year fixed and the HELOC becomes your first mortgage, or first lien.
Of course, you could also get a first-lien HELOC if you’ve paid off your house and own it outright.
Either way, now you have a mortgage that works like a credit card in that you can draw from the account at any time and pay it back if and when you draw. Having this kind of flexibility can come in handy if you need to draw from it to make ongoing home improvements and have to pay several contractors; if you have a child who’s getting ready for college and you need to pay their tuition and other college expenses; or if you have other debts that you’d like to consolidate.
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 loan with their mortgage, but there’s a significant amount of risk.
Because the loan is secured by your home, defaulting on the loan could lead to foreclosure, meaning you could lose your home. Also, HELOCs typically have a variable interest rate. It can rise and fall over time, making it difficult to predict exactly how much you will owe in interest.
Because of such risks, it is wise to talk to a financial advisor and also consider alternative loans. Luckily, there are other options that allow homeowners to dip into their equity or take out a loan to fund home improvements or other expenses.
With a personal loan, there's no risk of putting another lien on your home. In addition, personal loans are unsecured, meaning they don't require any collateral to secure the loan. However, because of this, they may come with higher rates. Banks, credit unions, or online lenders usually offer personal loans and can be used to finance almost anything.
Another option is a cash-out refinance, which is a type of mortgage refinance that allows homeowners to refinance their existing mortgage and access their built-up equity. It replaces the existing mortgage with a bigger loan and the difference is paid out in cash.
A cash-out refinance may be a better option for homeowners who prefer not to put another lien on their home.
Home Equity Loan
A home equity loan is another type of loan that allows homeowners to borrow against their equity. The home equity loan is secured by the home, and it’s paid separately from the mortgage.
When a homeowner takes out a home equity loan, they receive a lump sum of money and must repay the loan over a fixed period of time – between 5 and 30 years. The interest rate on a home equity loan is usually fixed, meaning it remains the same over the life of the loan.
Pros And Cons Of First-Lien HELOCs
There are several advantages and disadvantages of first-lien HELOCs.
- Greater spending flexibility: A HELOC is a revolving line of credit, similar to a credit card. However, HELOCs generally have repayment options with greater flexibility than most credit cards.
- Favorable interest and repayment terms: Homeowners with high-interest mortgages may find HELOCs at lower interest rates with better repayment terms.
- Can still lose the home: A HELOC is a secured loan, which uses your home as collateral. This means that if you fail to repay the HELOC, you could lose your home to foreclosure.
- Revolving debt: There’s a difference between revolving and installment loans. HELOCs are a form of revolving debt secured by your property, up to a certain limit. Installment loans give borrowers the entire loan amount as a lump sum, which they’ll be required to make regular payments toward until the loan is paid off. It’s much easier for revolving debt to spiral out of control and become difficult to pay off.
- Expensive debt: HELOCs come with closing costs between 2% and 5% of the amount you’re borrowing. If you plan to borrow smaller amounts, a personal loan might be a better choice, though these loans also come with closing costs.
First-Lien HELOC FAQs
Here are the most frequently asked questions about first-lien HELOCs.
Is a first-lien HELOC better than keeping a primary mortgage?
A first-lien HELOC could be a better option over your primary mortgage if you can make the payments and are in the right financial position to do so. Not only will a first-lien HELOC replace your mortgage, but it gives you access to your home’s valuable equity.
Are there limits on how much I can borrow with a HELOC?
Similar to other types of loans, HELOCs come with borrowing limits. Most lenders will only approve a HELOC with a loan-to-value (LTV) ratio of 80% – 85%. This means you must have at least 15% – 20% equity in your home to qualify for this type of financing.
Can I sell my home if I have a first-lien HELOC?
Yes, you can sell your home if you have a first-lien HELOC. The HELOC is paid off at closing.
The Bottom Line
First-lien HELOCS are the same as any other HELOCs, except a first-lien HELOC sits in the first-lien position because there is no primary mortgage. They also provide homeowners with great advantages, like flexibility, liquidity, tax advantages, and a low-interest rate. But there are risks associated with this type of financing, including debt that could easily get out of control and you could possibly lose your home if you default on the loan. It’s best to speak with a financial advisor about your specific situation.
Apply online now if you decide a home equity loan or cash-out refinance better suits your needs.
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