Home equity line of credit vs. home equity loan.

[Ralph]

I plan on buying a 2nd small single family home as investment property using either a home equity line of credit (HELOC) or a home equity loan.(HEL)

I've been approved for 185K --using a HELOC I'm looking at 5%--but it's a variable rate.

A HEL is fixed but the rate is 6.2% for a 30 year loan.

Fees are minimal (a few hundred dollars) on both.

The loan officer is suggesting I go with the variable rate and simply keep a close eye on interest rates. The HELOC has a conversion privledge allowing it to be converted to a fixed rate HEL if I so desire.

The assumption he's making is that due to the "recession" were in--it's highly unlikely you'll see rates going very high---making the variable rate a better deal--and if rates do change--you can always use your conversion option....

Anybody dealt with a situation like this recently?.............

[Thanz]

Is this loan secured against your current home or only against the second home? Is it your intention to rent out the second home? What are the early payment terms for each? What are the minimum payment terms for the LOC?

I'm in Canada, and it seems that the mortgage market is quite different. Here, your mortgage term is typically much shorter than the mortgage amortization. My current mortgage is a 3 year mortgage that floats at .85% below the prime lending rate. It is coming up for renewal soon, but over the three years has been great as rates have dropped. I kept my payments the same, which had the effect of paying off sooner.

I think that the HELOC might give you greater flexibility, and be cheaper.

[madurobob]

Hmmmm... I *think* the HEL is smarter, but its a gamble. The HELOC is intended to give you access to equity that you will use here and there as necessary, often for a construction project. You pay interest only on money you draw out of the equity line. The HEL gives you all the money upfront and you pay interest on the whole shebang from the beginning.

Usually the term on the HELOC is shorter - like ten years. After that you have to repay it all or re-apply to extend the loan. With the HEL you in effect have a 30 yr mortgage with a fixed rate. I think that makes the HEL a safer long-term source of funds for your second house.

[Huh-What?]

There are a couple of questions that need answering.

How long do you plan on keeping the investment?
Market. How easy is to get renters in that neighborhood and at how much rent can be charged?
Does that rent cover costs of mortgage, taxes, insurance, repairs, and maintenance?
If there is extra cash flow what will you do with it? Use it for personal bills? Payoff the investor loan? Party hard?

If you are in positive cash flow then you can use the HELOC to its full advantage. Put extra cash to payoff the loan and pull it out for repairs when needed. The extra money will lower your payment and the next month more of your rent will be applied to your principal. This frees up equity quicker and keeps the total interest you pay much lower then a fixed amortized loan (even if you send the bank the extra cash).

If you are not in positive cash flow then you might want to consider the fixed loan as you may not want the investment property to eat any more of your personal monthly budget in the future when the adjustment may be upward.

[Stormraven]

Speaking as a mortgage worker (though only tangentially on the production side, I do know a bit about the products), the difference is pretty straightforward.

The HELOC payments will be interest-only for the duration (usually ten years) of the LOC. You can, of course, always pay more. As mentioned up-thread, at the end of that time, you either have to pay it all off, or convert it. (Many that I've seen convert automatically). The usual term on a conversion is a further 10 years, though some might go to 20.

The HEL is, again, fixed rate, and the payments you make each month are fully amortizing. They'll be greater than your payments on the HELOC, but assuming you use the full amount ($185k) the HELOC payments after conversion will likely be higher, even if you end with a lower interest rate.

[Ralph]

[QUOTE=Stormraven;3530614

The HEL is, again, fixed rate, and the payments you make each month are fully amortizing. They'll be greater than your payments on the HELOC, but assuming you use the full amount ($185k) the HELOC payments after conversion will likely be higher, even if you end with a lower interest rate.[/QUOTE]


I do plan on using the full amount....with todays rate decrease the interest only payments on 185K @ 4.75% would be about $730. (The draw period is 10years--payback is 25. I plan on buying a small house that I'm going to rent out to my daughter--sell it when I retire in about 10 years)

There are no penalties/loads to convert to the HEL---Payments on that would be about $1100/mo---of course now the interest rate's fixed & I am paying off some of the principle.

I think long term--rates will eventually rise---it's very tempting to think they're at bottom now and convert to a fixed at this point.

[CriticalThanking]

As a follow-up to Stormraven's comments, note that some HELOC lenders are cutting off the line of credit if the collateral property decreases by more than x% in value or if the amount of equity available drops by 10x%. Just to pull numbers out of thin (or thick) air, you could assume x = 5 for cetain lenders. So if you use your entire LOC, then you may be immune to the cutoff issue. Check the loan terms about what would happen should your collateral lose value.

CT