HELOC question

[bassman2003]

The wife and I are considering a HELOC.  Just wondering if anyone had any thoughts, suggestions, or other ideas.  Here's the situation.

We bought a 1970's house that is in good condition, 3 years ago, are gradually starting to renovate the parts of the house that are original (bathrooms, kitchen, replace carpeting with hardwood on main floorf).  We are going to cash flow a decent chunk of the renovations (have about 20K set aside), and room in our monthly budget to chunk towards it (not included in our savings rate).  Our savings rate is a comfortable 40-45%, with about 150k in net worth.  Both of us work, very steady industries (I'm in healthcare), not very worried about losing jobs (even if we did, we have emergency savings and could easily live off one salary, would just have to reduce savings rate for a brief period of time).  We have 2 three year old children (twins).  No debt other than mortgage.

We want to use a HELOC as an additional amount set aside for house renovations.  We might not even have to dip into it if we spread the renovations out over a 4-5 years.  The HELOC has no up-front fees, and we could lock in a 3.11% rate for up to 12 years (reduces to 2.86% because we would do direct draw from our checking).  FICO is 800ish, so we qualify for top rate.  The loan to value ratio is up to 85% (on top of the mortgage obviously...we're at about 65% already on our mortgage, but the 20% value of the house would be way more than enough for our needs).  Our bank (a major national bank), said they do the appraisal electronically, so I assume its a conservative estimate on the appraisal, but we don't have to pay any $ for the appraisal.  The other banks/credit unions we looked at would do 90-100% LTV, but required us to pay for an appraisal.  The other credit unions/banks rates were typically 3.25%, with $400-$500 up front for appraisal and fees.

Our current mortgage is a 30 year 3.625%.  It seems crazy to me that a HELOC would be about 0.8% cheaper than our mortgage.  We do have better credit scores now (740 when we bought the house, 800 now, so I'm not sure if thats it).  It seems crazy to me to not sign up for this today, then just use it only as needed for the next decade.

Any thoughts on this?  Is this too good to be true?  Do I need to ask any additional questions before starting the application process?  Thanks!

[AMandM]

Does the HELOC involve closing costs?  If so, you're paying for the mere possibility of borrowing money you don't need.

Even with no fees, I personally wouldn't bother with the HELOC.  I would cash-flow the renovations, partly to avoid paying interest and partly because I'd be afraid that having the larger HELOC sum available would lead me to spend more than I really should or want to.

Here's a different idea:  can you use the lower HELOC rate to reduce your mortgage, thereby effectively paying the HELOC rate instead of the mortgage rate on part of your mortgage?

[frugaliknowit]

What do you mean by this:  ...we could lock in a 3.11% rate for up to 12 years (reduces to 2.86% because we would do direct draw from our checking)....?  Normally a Heloc rate is variable.  As a "teaser", the bank may offer a lower rate for a limited time. 

Are you saying the rate is fixed for 12 years at 3.11/2.86?  That doesn't sound right...

[bassman2003]

Thanks for the replies.

This particular HELOC doesn't have any closing costs.  The other credit unions I have visited have $400ish for 'closing', which pays for the appraisal.  In that instance, we still 'own' the appraisal, and could use as we see fit, in case we wanted to ultimately go with another bank.

The women at the bank told me the interest rate was fixed for the duration.  Would be 2.86% with a period of 144 months.  The other banks told me their HELOC rates were variable based upon prime rate, were 3.25% currently, but were set once I borrowed money (couldn't be raised in the future)

[DoubleDown]

I think having a HELOC to draw upon is a great resource. Obviously it shouldn't be used as a magical source of "free money", but assuming you're prudent and only use it when it makes sense, then it's great to have. We use ours as an emergency fund (have never had to use it for that purpose), or if we have any large renovations we want to fund over the long term -- things like roofs, HVAC replacement, large remodeling projects. I don't really think "cash flowing" renovations like that (as suggested by an earlier poster) is realistic or preferable for most of us. If you've got $20k, $30k, $40k or more cash sitting around "just in case" and not working for you, you're likely missing out on substantial investment returns.

Since you can get one with no closing costs, I see no downside to opening it and then using only as necessary.

[frugaliknowit]

The women at the bank told me the interest rate was fixed for the duration.  Would be 2.86% with a period of 144 months.  The other banks told me their HELOC rates were variable based upon prime rate, were 3.25% currently, but were set once I borrowed money (couldn't be raised in the future).

I think you might be confusing a Heloc with a Home equity loan (I used to have a Heloc).  While I have not been shopping lately, I have NEVER heard of a heloc where your rate on the line or any amount of the line is locked in, except for teaser promotions at the beginning.  I would check all of the fine print...think of it from the lender's point of view; why would they agree to that?

[boarder42]

wanna disclose this bank offering no closing costs? i have a couple reno's i'd like to do. and if i can get a 2.86% and no close sign me UP!

i'll probably end up just putting it into VTSAX b/c i'm a cheap ass but still.

[dinkhelpneeded]

Yes! This happened to us, we thought we were getting a HELOC, we were actually getting a home equity loan, which means you have to take the full amount immediately - unlike a line of credit, where you can take it out when you need it.

So expect to pay 2.86% and monthly payments irrespective of whether you are using that money or not. The moment you return the full amount, it resets back to your variable rate and becomes a true HELOC.

A true HELOC will have a variable rate and you pay nothing if you never need it.

[With This Herring]

The fixed rate is surprising.  Are you sure that they are saying that, even if your first draw/borrowing is in Year 11 when hypothetical interest is at 6% for borrowers with good credit, it will still be at that low, low rate?  That would be a highly atypical offer.

Is it possible the actual terms are: "Anything you borrow in Year 1 will only accrue interest at Low Rate through Year 12, assuming it takes that long for you to pay it off.  New borrowings in Years 2 through 12 will accrue interest at their respective Annually Calculated Rates, following the formula* in our agreement.  Payments in excess of interest will be applied to the various principal amounts on the following basis...++"
*Formula is usually something like "Prime/LIBOR plus X basis points" for businesses; I assume it is similar for individuals.
++ Could be "borrower's choice" (and you would choose highest interest-incurring first), lowest interest-incurring first, in proportion to amount, in order of borrowings, or any other method.

Ask what the rules are for repayment.  Some possibilities:

• Is the principal repaid solely at your discretion, with just monthly interest payments meanwhile?
• Is the entire principal balance due at the end of Year 12, no matter what else happens?
• Is the loan subject to review annually to determine if you/your house still qualify?  (and failure to qualify turns it from a HELOC to an amortized loan payable monthly like your mortgage, but possibly over a significantly reduced timeline)
• Once you borrow, does the bank set up an amortization schedule for repayment over X years?
• Or does the bank keep it as a plain HELOC until you say "Good news, reno is done!" and then set up that amortization schedule?  This is done for some construction loans for businesses.

If the terms let you pay off the principal whenever, I agree with AMandM that it would make loads of sense to just use it to the max to pay off as much of your mortgage as possible (assuming that this turns out to be better than a possible refinance).

Does the HELOC involve closing costs?  If so, you're paying for the mere possibility of borrowing money you don't need.

Even with no fees, I personally wouldn't bother with the HELOC.  I would cash-flow the renovations, partly to avoid paying interest and partly because I'd be afraid that having the larger HELOC sum available would lead me to spend more than I really should or want to.

Here's a different idea:  can you use the lower HELOC rate to reduce your mortgage, thereby effectively paying the HELOC rate instead of the mortgage rate on part of your mortgage?

[bassman2003]

Thanks so much for all the replies.  A couple of items.

I don't mind mentioning the bank board42, its a local branch of PNC (bank with whom we have our checking).  I have also investigated offers from several local credit unions in our Midwest city.

To my understanding, they are offering a HELOC, unless the bank person was totally unsure of the product they were offering.  They stated I would get both a debit card and a checkbook that would specifically withdraw from the HELOC account.  I have never heard of a home equity loan with these.  In a loan, I'm assuming they would just transfer the money to your checking account in that case.  Up until this point though, I had never heard of a HELOC with a fixed rate for the entire duration of availability :)

Assuming it was an actual HELOC the person at PNC offered me, she did mention that the 144 month term for the HELOC was the longest term that still had the availability of the lowest interest rate.  Apparently, they also offered a 15 year term (and maybe even a 20 year term) but the interest rate was would be increased from 3.11% (which for us has an effective rate of 2.86% with the 0.25% rate reduction due to automatic withdrawal from checking).

I did discuss this with a client of mine today (he's a retired executive of a credit union).  He referred to it as something like a close ended HELOC on an automatic amoritized schedule.  He said HELOCs were rare to be fixed rate through the entire period, but they did exist.  He said the kicker was that the minimum payments would be amoritized through the end of the 144 months, no matter when I borrowed the money.  For example, if I waited till the 10th year to borrow anything on the HELOC, that amount would be amoritized over a 24 month period, making the payments likely fairly significant if I borrowed close the the capacity of the HELOC.  But I would still be locked in at the 2.86%.

Dinkhelpneeded: They led me to believe that I could withdraw nothing or as little as I needed when I first opened the account.  Although, there is a chance that the product they are offering could be similar to yours, but thats not what I was led to believe.  That's a great question to ask them to clarify though.  Thanks!

With This Herring: As far as I know for repayment, they automatically amoritize the minimum payment amount to the end of of the 144 month period.  Anytime I borrowed, they would refigure the minimum monthly payment, but it would always be amoritized to the end of the 144 month period.  No matter what, the amount owed on the HELOC would be $0 by the end of the 144 month period if all payments were made on time.  They did not mention anything about it being subject to an annual review.  In a city with extremely stable housing prices and an LTV of only 85%, I assume they would not be as concerned about this.  But that's another great question to ask.

The reason why I queried people on this board, is that even though I have a basic understanding of HELOCs (and home equity loans), this specific offer really piqued my interest and I was curious if anyone had ever used a similar product.  Or perhaps the bank person misunderstood the product, but it seemed like the banker knew what she was talking about.

Thanks so much for everyone's help so far!

[boarder42]

Alright so I just got on their website it appears to be a home equity loan fixed at 3.11% for up to 50k borrowed over 10 years. If you use your checking to direct pay it knocks the .25%off.  I may do this and invest it.

their HELOC rates are variable so it is highly probable she was confused.  but still a HEL for 2.86% is a bargain.

[bassman2003]

Thanks for the help.  Apparently at the bank the worker was right about the product, but was pairing it with the wrong interest rate.  Their home equity loans have interest rates in the high 2's.  For their home equity line of credit, they have something called a 'fixed rate lock option'.  Works like a standard HELOC, but locks in the rate for the entire term of the credit line.  The rates for those are about 4.4%.  Thanks again for all the replies.