Weekly Rate & Market Update 2-3-17
Question: Should I get a Home Equity Line of Credit, if so how does it work?
Answer: This question has come up frequently in the last few months, usually as part of a bigger question regarding remodeling your home and how to pay for it. Last January I discussed options for paying for a remodel of your current home, and encouraged you to weigh going through the remodel against buying the home you desire.
Those options are still there: new cash out mortgage, a Home Equity Line of Credit (HELOC) or paying cash, or a combination.
Of the available options the most mysterious to many homeowners is the HELOC, what is it, how does it work? When looking for a HELOC what are the factors I should consider?
A HELOC works very much like a credit card. You are approved for a credit limit and you can use and pay down, and use and pay down and use…through what is known as the “draw period.” During this period your minimum payment is typically interest only. Interest is calculated by taking the published Prime Rate (lender will let you know which bank’s or publication’s Prime Rate it is using to establish your rate) and to the Prime Rate a margin will be added. If the draw period is not equal to the term of the credit line then when the draw period is up the ability to obtain funds from the HELOC is no more and the lender will generally fully amortize your payments for the remainder of the loan.
Let’s put some numbers to the explanation and make it a bit clearer for you:
You apply for and are approved for $100,000 HELOC. The lender says the terms are Prime + 1, the draw period if for ten years during which you must pay interest only on any outstanding balance and the total period of the loan is twenty years.
Currently the Prime Rate is 3.75% so the rate on any outstanding HELOC balance is 4.75%, until the Prime Rate changes at which point your rate will decrease (unlikely in short/medium term) or increase (very likely short/medium term).
You want to put in a new garage door and add cabinets to the garage, the cost is $10,000 and you decide to use your HELOC to pay for the work. After you take the funds out you get your statement for the first month and it shows you have a $10,000 balance and $90,000 still available for use. The rate is 4.75% on $10,000 so the interest due for the month is $39.58 (10,000 x 0.0475 = $475 for 12 month period, or $39.58 for the month) which is your minimum payment.
Having some additional funds you pay the interest plus another thousand dollars for a total of $1039.58. You do not use any more funds in the coming month so your statement shows a balance of $9,000, but right at the billing cycle the Federal Reserve raised their Fed Funds rate by 0.25%, as a result the Prime Rate also increased so your rate is now 5% (Prime = 4% + margin of 1%). Your account has accrued interest of $37.50 which is the minimum payment due and you have available credit of $91,000. You pay just the interest this month as you use additional funds you have for the month on fixtures, etc for the refinished garage.
Having finished the garage you realize that the exterior paint doesn’t look as good as it did before the new garage door so you hire a painter to paint and patch your home and the cost is $18,000 which you put on your equity line.
Your monthly statement comes and it shows you have an outstanding balance of $27,000, the Fed raised rates again by 0.25% so your rate is 5.25%, the interest you have accrued for the month is $118.13 which is the minimum payment due. You have available credit of $73,000.
And so it goes for the ten year draw period. You borrow the money on the HELOC, make your minimum interest payments some months and others when you have more funds available make payments to lower the principal balance. During the period rates fluctuate up and down and your monthly interest rate adjusts accordingly.
At the end of the ten year period you have a balance of $62,000 on the HELOC and the Prime Rate is 6.25%, your interest rate is Prime + 1 so your rate is 7.25%. The bank has informed you sixty days before that your draw period is coming to an end and in two months you loan will become fully amortized for the remaining ten years of the loan.
To amortize the loan the lender will take your outstanding balance, the number of months left on the HELOC and the current interest rate and calculate what the payment would need to be to make the same payment every month so at the end of 120 monthly payments your balance will be zero.
With $62,000 balance and a 7.25% rate your monthly payment the first month of no longer having the interest only option is $727.89, of which $374.58 is interest and $353.30 is principal. You make the minimum payment.
Coincidentally once again, the Feds raise the rate on the same day of your billing cycle to 6.5%, you HELOC rate is 7.5% and your balance is now $61,646.70 and you have 119 months left to pay off the balance. Your payment for the month is $735.89, a bit higher due to the rate increase.
For the next ten years your payment will adjust depending on the Prime Rate and your outstanding balance and the number of months you have left on your HELOC before it is to be paid in full.
Even if we were not coming off years of historically low interest rates, when getting any type of adjustable loan you should assume your interest rate will go up during the life of the loan. What may be a comfortable payment today may not be next month, year or in five years. As well since the rate is adjustable you should pay down the principal as much as you can as soon as you can to mitigate future rate increases.
Most banks and credit unions offer HELOCs, so what factors should you consider when looking for a HELOC and considering where to apply?
The primary factor is what is the margin over the Prime Rate for the interest rate you will be paying? Does the margin vary depending on how much you apply for, i.e. is the rate lower for $150,000 credit line as opposed to $75,000? Does the margin vary if the combined total of my current mortgage and my new HELOC exceeds a certain percentage of my home’s value, i.e. is the rate higher if the combined totals of the loans exceeds 80% of the value of my home?
Next what are the terms of repayment? Is the draw period short or long? After the draw period is up is the remaining balance amortized or can you still pay interest only? How long is the period the loan may be amortized?
Finally, what is the cost up front for the HELOC and what, if any, is the annual maintenance fee?
For many clients calling over the past few years inquiring about HELOCs I have suggested they contact their credit union instead of a major bank. While Stratis Financial does have some equity lines available I find the terms for many/most credit unions are better than what we can offer, and better than any of the major banks in the region. Particularly in the amount they will lend as a percentage of the value of your home and typically with the margin over Prime as well. If you don’t belong to a credit union research them anyway as these days many credit unions allow members beyond what their traditional charter called for—for instance I have accounts with a credit union that used to be exclusively for tele-communications workers, and in the past have had accounts with local teachers credit union, even though I have never been either.
I think equity lines are a very good financial tool to have handy if used wisely. They provide access to relatively cheap funds and due to their nature you can control your balances within your financial abilities.
My biggest piece of advice with having a Home Equity Line of Credit is to concentrate on paying down principal as soon as you are able so you are not caught in a difficult financial position many years down the road.
Finally, if you do have a HELOC and sell your home it must be paid off with proceeds from the sale, a lender will not let you carry it to your next home. As well if you are refinancing your current primary mortgage the total loan limit of the HELOC will be a factor in determining ability to qualify and possibly your interest.
Remember, with Dennis it’s not just a mortgage, it’s your complete financial picture.
December saw moderate gains in personal wages and salaries, increasing 0.3% after being flat in November. While wages had a moderate increase personal consumption so a more robust increase of 0.5% from November, mostly for durable goods—especially autos. With higher consumption increasing more than wages it is not surprise that the personal savings rate dropped for the month. For the year the personal price index increased a modest 1.6%, well below the target for the Federal Reserve. Overall the news is neutral for mortgage rates.
The monthly employment data for January was released today and new jobs for the month strongly exceeded expectations, with 227,000 jobs added for the month. The total exceed the monthly average of 187,000 for 2016. The best news in the report was that the private sector added 237,000—which means government employment decreased—and the participation rate increased. Hourly earnings increased only 0.1% for the month and the unemployment rate increased 0.1% to 4.8% as more people sought work. The news is somewhat mixed in that the number of new hires is good news but not keeping up with new job seekers tempers the positive. Overall the news is somewhat positive for rates as the data would suggest the Fed may not increase the Fed Funds rate at its March meeting.
Rates for Friday February 3, 2017: Still some inter-day instability in rates as investors try to process all the information and possible ramifications coming out of Washington, but a little less than in prior week(s). Week to week we are flat from last Friday as rates show resistance at the 4.125% level we have bounced off of three times in the past seven weeks. Looking ahead I maintain my advice to lock in your rate when you can through your rate period.
FIXED RATE MORTGAGES AT COST OF 1.25 POINTS
30 year conforming 4.00% Flat
30 year high-balance conforming 4.125% Flat
30 year FHA 3.50% Flat
30 year FHA high-balance 4.00% Flat
Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down (3.5% for FHA) with 740 FICO score for purchase mortgages.
Very busy weekend for the Smith family that should be a lot of fun. As many of you know our family moved to Brussels, Belgium after my freshman year in high school and I spent my sophomore through senior years in Belgium graduating from the International School of Brussels. Tonight Leslie and I are hosting a gathering of other ISB alumni in the Southern California region. We are expecting to have Mr.Vantieghen, the Belgian Consul General in Los Angeles make an appreance along with ISB Raiders who attended the school from the 1960s to more recent years. We have plenty of excellent Belgian beer on ice and look for to reminiscing about our years in Brussels.
Tomorrow we welcome to our home a student from a town outside of Paris who will be with us for the next two weeks. Our French visitor is about the same age as our oldest daughter, and no surprise they have been texting and Snapchatting each other with regularity. We look forward to sharing our home, city and region with her and learning about her life in France—as well as dusting off our French vocabulary and ability to coherently communicate.
Our Super Bowl will be a teenage affair as our daughters have invited several friends to our home to ostensibly watch the game, but more importantly to meet Mallory so she is more comfortable when she starts walking the halls of Poly High on Monday. No word yet on whether she is a Patriots or Falcons fan!
So the Super Bowl will be a bit of a background component to our Sunday, and not having any significant affinity for either team that is just fine by me.
I hope you have a great weekend and are entertained as much as you desire by the game on Sunday. My predictions have not been great so I’ll make one more—the Patriots in a very high scoring game (over 70 total points) and covering the 3 point spread Vegas has put out.
Have a great week,
Dennis
