Home equity lines of credit, or HELOCs, have become a popular financing option for homeowners who need funds for major expenses or renovations. While second-lien HELOCs are the most common type, first-lien HELOCs can also be an attractive option.
A first-lien HELOC is a home equity line of credit that is secured by the borrower’s primary mortgage, meaning that it has priority over any other liens or loans on the property. This type of HELOC offers unique benefits, and understanding how it works can help homeowners make informed decisions about their financing options.
What is a First-Lien HELOC?
A first-lien HELOC is a revolving line of credit that allows homeowners to borrow against the equity in their homes. Unlike a second-lien HELOC, which is a subordinate lien to the first mortgage, a first-lien HELOC is secured by the primary mortgage. It means that if the borrower defaults, the lender has the right to foreclose on the property and use the proceeds from the sale to pay off the outstanding balance on the HELOC. As a result, first-lien HELOCs have priority over any other debts or liens on the property.
How Does a First-Lien HELOC Work?
A first-lien HELOC is a financial product that allows homeowners to borrow against the equity in their home, using their property as collateral. The amount of equity available to borrow is determined by subtracting the outstanding mortgage balance from the current market value of the home. For example, if a home is worth $500,000 and the outstanding mortgage balance is $300,000, the available equity is $200,000.
When a borrower applies for a first-lien HELOC, the lender will assess the borrower’s creditworthiness and ability to repay the loan. If approved, the borrower will be given a credit limit, which is the maximum amount of money that they can borrow against their home equity. The borrower can then draw on the HELOC as needed, up to the credit limit, and only pay interest on the amount borrowed.
The interest rate on a first-lien HELOC is typically variable, meaning that it can fluctuate over the life of the loan, based on market conditions. This can be advantageous for borrowers when interest rates are low, as they can benefit from lower monthly payments. However, if interest rates rise, the borrower’s monthly payments can increase, which can be a disadvantage. Some lenders may offer the option to convert a portion of the HELOC balance to a fixed-rate loan, providing more stability and predictability in payments.
The borrower can choose to pay only the interest on the HELOC each month or pay both principal and interest, depending on the terms of the loan. It is important to note that if the borrower chooses to only pay the interest, the principal balance will not decrease, which can lead to higher payments in the future.
To avoid this, it is recommended that borrowers make both principal and interest payments, especially if they plan to keep the HELOC for a longer period of time.
Advantages of a First-Lien HELOC
Lower Interest Rates:
One of the primary benefits of a first-lien HELOC is that it typically offers lower interest rates than other types of loans or credit products. Since the loan is secured by the primary mortgage, it is considered less risky by lenders, which can result in lower interest rates.
Flexible Payment Options:
Another advantage of a first-lien HELOC is that the borrower has flexibility in making payments. They can choose to pay only the interest on the HELOC each month or pay both principal and interest, depending on their borrowing needs. This can help borrowers control their monthly payments and reduce the financial strain of large payments.
Potential Tax Benefits:
The interest paid on a first-lien HELOC may be tax-deductible, as long as the funds are used for home improvements or other qualifying expenses. This can help reduce the overall cost of borrowing and provide additional financial benefits for homeowners.
Increased Borrowing Limits:
Since a first-lien HELOC is secured by the primary mortgage, lenders may be willing to offer higher borrowing limits than other types of loans or credit products. This can provide homeowners with access to more funds to finance their home improvement projects or other major expenses.
Last Word
A first-lien HELOC can be an attractive financing option for homeowners who need access to funds for home improvements or other major expenses. This type of HELOC offers several advantages, including lower interest rates, flexible payment options, potential tax benefits, and increased borrowing limits. However, it is important to understand the risks associated with borrowing against the equity in your home and to carefully consider your options before making any financial decisions. Homeowners should consult with a financial advisor or mortgage professional to determine whether a first-lien HELOC is the right choice for their needs.
