March 7th, 2013 10:59 AM by Richard T. Cirelli
HELOC’s & Piggy-Back’s
HELOC’s, formally known as Home Equity Lines of Credit, were once as easy to get as a loaf of bread. But, when the economic crisis hit in late 2006, they were the first mortgage product to become extinct. Now, thanks to increasing home values and consumer and lender confidence, they are emerging once again. HELOC lending increased by 31% last year and is projected to increase again by about the same percentage in 2013. Once used to finance 100% or even 125% of the value of the home, today’s terms are more conservative and they are only offered by a few lenders. But, they are an important mortgage product to the housing and economic recoveries.
How Does a HELOC work?
A HELOC is typically a second mortgage that gives the borrower the ability to use the equity in their home if and when it is needed for just about any purpose. Home improvements and down payment to buy a new home are the most common. The borrower can use all or part of the line of credit and only make payments on the portion used. If the HELOC is paid back in full or in part, it can be used again later. Once again, payments are made only on the used portion. Minimum payments are typically interest-only for the first 10 or 15-years but borrowers can make principal payments at any time without penalty if they choose to pay the balance down. After the initial 10 or 15-year period, they convert to an amortizing loan requiring principal + interest payments until completely paid off at the end of 25 or 30 years. The interest rate is always variable and tied to the Prime rate plus an additional margin. Currently, the Prime Rate is 3.25% and the margin typically charged by banks is 1.5% for a total rate of 4.75%. The Prime Rate has been 3.25% for a few years now but will eventually rise. Most HELOC’s come with no closing costs.
Piggy-Back Loans to Purchase a Home
At the height of their popularity in the early 2000’s, homebuyers would often use a combination first and second mortgage or “piggy-back Loan” to purchase their home. Borrowers might take out a first mortgage up to 80% of the purchase price and a HELOC for 10% to 20%. This enabled the buyer to not only avoid the expense of Private Mortgage Insurance (PMI) but also minimize or eliminate the need for a down payment. These were also known as an 80/20 or 80/10/10 loans. Today’s HELOC’s are limited to 80% - 85% of the purchase price, still requiring a down payment.
The main advantage of a HELOC are that they may allow a homebuyer to take advantage of the lower interest rates available for loans up to the Fannie Mae/Freddie Mac maximum limit of $417,000 – to $625,500 depending on the local market. If the Purchase price is such that the buyer wants to finance more, they may use a HELOC or “Piggy-Back” financing for the extra amount needed after making a 15% or 20% down payment. When used to 85%, it also serves to eliminate the need and expense of Private Mortgage Insurance.
Qualifying for a HELOC:
In addition to a minimum 10% - 15% down payment or equity, these loans are usually restricted to the borrower’s primary residence, they require minimum credit scores of 700 and the borrower must qualify with the HELOC payment factored into their qualifying Debt-to-Income ratios. Maximum loan amounts are usually $250,000 - $350,000 not to exceed 80% - 85% of the value of the property when considered with the first mortgage balance. HELOC’s can also be used as a first mortgage when no first mortgage exists.
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