When interest rates were at historic lows, refinancing a mortgage was for many a sensible way to save money and fund big purchases--like renovations or school tuition--using your home as collateral. But in the last few months, rates have inched up, making refinancing less attractive.
Now, with property values at their highest in years, NYC apartment owners in need of extra cash but reluctant to lose the rock-bottom rates on their mortgages are beginning to turn to home equity lines of credit (HELOCs) and home equity loans--both of which had virtually disappeared after the 2008 financial crisis, when banks became extremely wary of lending to all but the safest borrowers.
“It is a bit more stringent than it was pre-Lehman, but it is more flexible than a couple years ago," says Sunny Hong, a mortgage banker with DE Capital.
Should you use a HELOC or home equity loan to get cash out of your home? Here’s what you need to know.
Home equity loan vs. home equity line of credit
Both home equity lines of credit and home equity loans are types of debt that, like a mortgage, use your abode as collateral. But while a home equity loan comes in a more traditional lump sum (with fixed interest payments), a home equity line of credit is almost like a credit card with a very high limit (and variable interest payments).
Like a credit card, once you pay down your balance on a HELOC, you then have more money available to spend again. The line of credit also has a variable interest rate and payments can change every month depending on how much you spend (up if you spend more, down if less), or because of interest rate changes.
The rates are tied to the prime rate or another rate index, plus a margin that a bank takes, which could be as high as two percentage points. While your rate could start off at 3.25% (that would be the prime rate plus 0 points), it could bounce up at any point, and it will never fall below the federally set prime rate. The most common increase for rates is because the federal prime rate has changed, and your rate will reflect this. But note that rates don't tend to undergo extreme fluctuations over time.
(Here's a tip for cutting your interest-rate risk, from senior home loan consultant Ali Kamalzadeh of First Choice Bank: "Most if not all HELOCs offer you the ability to lock in portions of the line drawn," says Kamalzadeh. "So for example, if you have a $100,000 credit line and have used only $35,000, you can call in and request that $20,000 of the $35,000 be locked into a fixed rate for the remainder of the balance until paid off.")
When you sell your place, the HELOC is paid off--meaning you can’t sell and keep the home equity line.
The same is true with a home equity loan. Unlike a HELOC, however, a home equity loan disburses all funds at one time when the loan term starts, and you cannot access any further funds without refinancing the loan. The home equity loan has a fixed interest rate and payments don't change.
A home equity loan is more stable overall, as it's usually a longer term fixed-rate, which you're paying over time. So if you're looking for stability, a home equity loan may be for you. If you prefer flexibility and can take a chance on rates going up or down, a home equity line of credit may be more your speed.
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Rates, closing costs, and tax advantages
With credit card interest rates between 7 and 20 percent and student loan rates between 3.9 and 6.8 percent, home equity lines of credit are relatively cheap money right now.
Many banks also offer a better rate if you maintain a large savings account with them, or set up automatic payments for the line of equity, so be sure to shop around and ask.
Like mortgage loans, HELOCs come with closing costs such as application fees, title search, an appraisal and attorneys' fees. You may be able to avoid them if you keep the line of credit open (and therefore keep your home) for a minimum of three years, says Robbie Gendels, a senior loan officer of National Cooperative Bank in Manhattan.
Rolan Shnayder, a mortgage banker at H.O.M.E. Mortgage Bankers, confirms that in some cases, banks will waive closing costs or charge as little as $500.
In the case of home equity loans, however, you'll likely have to pay closing costs when you get the loan, Hong says.
On the bright side, both home equity lines of credit and home equity loans both come with tax breaks for interest payments.
Gendels and Hong recommend consulting your accountant before taking out a HELOC or home equity loan to learn more.
To qualify for home equity lines of credit and home equity loans, banks commonly require that you have at least 20% equity in your home--meaning that you don't owe more than 80% of what your home is worth, says Gendels. They will typically lend 80% of a home's value, she says. So if your apartment is appraised at $500,000, and you own it outright, a bank will lend up to $400,000.
Additionally, you will have to comply with the bank’s debt-to-income ratio, which is generally no more than 43%, though that may be increased on a case-by-case basis for a strong applicant with a good credit history and credit score, says Gendels.
Though a HELOC may seem like a credit card, don't treat it that way. Your property is on the line, and you should spend with that in mind. Rather than taking the maximum amount your bank will lend, request the amount you actually need. For example, taking out $200,000 for a renovation budgeted at $45,000 makes it extremely easy to go over budget.
Don’t become too dependent on your HELOC either, as banks can close it suddenly if they believe your property value has declined. If that happens, your repayment terms would stay the same, but you wouldn't be able to access any additional funds, Shnayder says.
Co-ops vs condos
Not all banks will do home equity loans and HELOCs in co-ops. The fastest way to find out if your co-op building qualifies is to contact your management company for a list of banks that have recently issued loans in the building.
And just as a co-op board will need to approve a mortgage or refinancing, it will need to approve a home equity line of credit and a home equity loan--and it can be an uphill battle, though not impossible.
Generally, boards don't want to approve a loan which puts you at risk of defaulting and endangering the financial health of the building. "A lot of boards are wary of people getting home equity lines," says Shnayder.
Approval standards differ by building.
“There’s no rule of thumb," says property manager James Goldstick of Mark Greenberg Real Estate. For example, he says, "some buildings do not have debt-to-income ratios, but many do. I’ve seen it as low as 20% and as high as 35%.”
In most co-ops, the average is around 28%, says Goldstick. This means that all of your debts—car payments, student loans, mortgage payments, and your monthly minimum home equity loan payment—have to account for 28% or less of your gross annual income.
Some buildings will have rules which limit what the loan can be used for.
“The co-op board can say no for home equity loans other than for renovations, so long as they are tied to the specific limitation, rather than a case by case basis," says Dean Roberts, an attorney with Norris, McLaughlin and Marcus. "If there is a rule saying 'renovation only’, which does occur, that will be enforced," and in this case, the board will likely want to see a renovation package presented along with a request for HELOC approval.
Goldstick says that it is important to be an owner in “good standing,” meaning that you pay your maintenance fees and any assessments in a timely fashion, and do not have any major complaints against you in regards to your residence.
If you own a condo, you won't have to deal with co-op board approval, but you should still make sure your building is on the bank's pre-approved list before getting started.