A hairstylist and his federal contractor wife -- both in their 30s -- lucked out when they bought their small Spanish-style house in January 2020. That was before the pandemic-fueled housing market frenzy pushed up prices. They’ve already amassed substantial equity in the place.
Now, the couple craves larger quarters. But they’re reluctant to trade up to a different house, given that they have a very low-rate mortgage, and a new first mortgage would undoubtedly cost them more in monthly interest charges.
“We’d be fools to trade our sweet 2.5% mortgage for one that would likely be over 6%,” the stylist says.
This couple is now exploring an alternative. They’re now working with an architect to design an addition that would add about 600 square feet to their current property.
“We love to have parties, and it would be great having an ‘indoor-outdoor’ room where we could host friends for brunches and barbecues. Our backyard is large and flat so this would be a relatively straightforward addition,” the stylist says.
The couple has already ruled out tapping equity for the renovation through the classic refinance of their first mortgage, which has more than $300,000 still outstanding. Instead, they’re pondering a home equity line of credit (HELOC), a type of second mortgage that works like a revolving credit line and is secured by a property.
“Of course, the interest rate on a HELOC would be higher than on a plain vanilla refi. But our loan amount would be far smaller. We only need about $30,000 for the addition,” the stylist says.
Demand for HELOC is very gradually building among millennial homeowners, according to Marc Zitelman, a mortgage broker who has worked in the lending field since 2002. He says many young adults, including those with growing families, would like to tap their equity but are reluctant to face the interest rate penalties associated with moving.
“Owners don’t want to disturb that low-rate primary mortgage they have,” he says.
Here are a few pointers for HELOC borrowers:
-- Research the HELOC market.
“It’s best to think through what you want before you shop around for the best type of home loan for your needs,” says Keith Gumbinger, a vice president at HSH Associates, which tracks mortgage markets throughout the United States.
As a first step, buyers can inform themselves through online resources. For instance, Gumbinger suggests that mortgage shoppers seek home loan information through his firm’s website: hsh.com.
-- Don’t settle for a lender offering shoddy service.
Gerri Detweiler, a consumer finance blogger and author of “The Ultimate Credit Handbook,” encourages first-time buyers to seek a lender who will instruct them on the complexities of all types of home loans.
“In just 30 to 60 minutes spent with a friendly lender, you can learn a lot about the fundamentals and maybe even get help to identify and fix flaws on your credit reports,” Detweiler says.
How do you find an empathic lender?
Gumbinger says real estate agents are often a good source for names. But he advises you to look beyond their suggestions.
“If you reach out in your neighborhood, you’ll probably find someone down the street who’s bought a house or refinanced lately. You can also canvass friends and family,” he says.
-- Arrive at your lender’s office prepared.
To save time, there’s no substitute for gathering key documents in advance of your meeting. Ideally, these should include recent pay stubs, your latest W-2s and a couple of years’ worth of federal tax returns, as well as bank and savings account statements.
Gumbinger says an in-person tutorial will help you clarify the whole lending situation and bring it into sharper focus.
What if the lender you contact resists your request for a tutorial? In that case, he says you should move on to another lender.
“You deserve to have all your questions answered in plain English,” Gumbinger says.
-- Look into your credit standing to get the best available mortgage rate.
Under federal law, you're entitled to one free credit report every 12 months from the three largest credit bureaus: Equifax, Experian, and TransUnion. You can easily request these online (annualcreditreport.com).
In addition to your credit reports you'll want to access your "credit scores." Such scores, which draw on data from the credit bureaus, seek to provide lenders with a quantitative measure of credit risk. Most lenders still use FICO scores, pioneered by the Fair Isaac Corp.
You may not need to pay a fee to obtain your credit scores because some banks and credit unions are now offering them free of charge. Another way is to buy them through the Fair Isaac website (myfico.com). In addition, you can also obtain them directly through the three large credit bureaus. FICO scores range from 300 to 850, and the higher the score, the greater your odds of getting the best available rate.
As Gumbinger says, you may want to begin the rate-shopping process with the lender who tutored you on the basics. But he urges you to extend your search beyond the first lender.
“The more the merrier when it comes to rate quotes. But always remember you’re looking for competent service along with low rates,” Gumbinger says.
(To contact Ellen James Martin, email her at email@example.com.)