Purchasing a home is exciting. It’s also expensive. What happens if you need money right away? Can you take out a home equity line of credit? Do you have to own the home for a certain amount of time? We answer these questions and more here.
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Seasoning Requirements Usually Apply
Many banks require a specific amount of seasoning. This means you must own the home for a specific amount of time. The average time is 6 months. This is what conventional lenders must require you to wait if you wanted to do a cash-out refinance. The HELOC is similar to that.
Even though the home equity line of credit works differently than a cash-out refinance, you are still tapping into the equity of the home. Lenders like to see you in the home for at least six months before they let you tap into that money. This way they know you are stable and able to afford your current mortgage payments. The last thing any lender wants is to put you in over your head. This puts you and them at risk for default.
Just like any other loan program, though, there are lenders with different rules. You may find a lender that doesn’t require any seasoning. This means you may get a line of credit right after purchasing your home. You may also find lenders that want at least 12 months of seasoning. Checking with different lenders and credit unions will help you understand your options.
Qualifying for the HELOC
Sometimes the timeframe isn’t the problem; it’s qualifying for the HELOC. Keep in mind, lenders take second lien position with a HELOC. This means they are second in line to get paid if you default. This may mean they get nothing. They may also get a little bit of money. Either way, they are at risk. They need to make sure you qualify for the loan before they give you any more money. Following are what most lenders evaluate:
Credit – Higher credit scores are often required for this loan. Without the higher score, you pose a higher risk. Lenders like to see a clean credit history with no late payments. They also don’t want to see overextended credit. A HELOC is basically credit. If you can’t show a history of managing your current credit properly, it would be hard for a lender to give you more.
What’s the magical score? It depends on your other factors. For instance, the higher your debt ratio, the higher the credit score a lender wants. If you have a low debt ratio, though, a lower credit score might be accepted. Lenders tend to look at the big picture rather than one factor at a time.
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Debt ratio – Your debt ratio shows lenders how much of your income already covers your current payments. A high debt ratio may mean you are in over your head. If this is the case, a lender won’t give you another loan. Every lender has a different requirement. A good general number to use is 45%. This pertains to your total debt. This means your car loans, student loans, mortgages, and credit cards. They can’t exceed 45% of your gross monthly income in order to qualify with some lenders. If you apply for a HELOC, you must figure the minimum payment into that debt ratio. Are you still at 45%?
Equity – Of course, a large player in your approval is the amount of equity you have. If you put down a large down payment, you may have a good amount of equity. If, however, you borrowed 95% of the sales price, you don’t have much to borrow. Many lenders don’t allow HELOCs for more than 85% of the value of the home. Unless you put a lot down, it could take you a while to get to that point.
Exceptions to the Rule
There is one major exception to the rule regarding HELOCs and seasoning. Some lenders allow the use of this loan to purchase the home. It’s not your first mortgage, but the funds do help you purchase the loan. This is called a Piggy Back Loan. You use the funds from the line of credit, the first mortgage, and your down payment to purchase the home. You may seem them called something like 80-10-10. This means 80% of the funds come from the first mortgage, 10% come from the HELOC, and 10% comes from you.
Many borrowers use this in an effort to avoid PMI. If you take out a conventional loan for more than 80% of the value of the home, you pay PMI. This adds to your monthly costs. Even though borrowing with a line of credit increases your costs, you can see a return on that investment. PMI payments aren’t anything you will ever see again. They are insurance premiums you must pay to insure the lender in the case of default.
Getting a home equity line of credit is certainly possible after purchasing a home. If you need the funds right away, you may have to shop around. Some lenders may use the original appraisal. If you know the values increased in the last 6 months, you may want to pay for a new appraisal. Keep in mind, the home equity line of credit is a risk for lenders. They will be very careful about who they lend to. They want good credit, low debt ratios, and low LTVs whenever possible.
Before you take out a home equity line of credit, consider your options. Are you able to pay back the loan on time? Will you make interest only payments or will you pay the principal too? A HELOC has a draw period and a repayment period. During the draw period, you only pay interest, if you want. During the repayment period, you must pay principal and interest on the loan. This could mean your payment as much as doubles.
Weigh all the pros and cons of a home equity line of credit before deciding the right choice for you!
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