Renovation Financing Part I: HELOCs

Cameron Puckett

Cameron Puckett, Pinnacle Financial Partners

You’re finally ready to pull the trigger on that home renovation you’ve been dreaming of for years. After crunching the numbers, you realize that it’s going to take more money than you have in your savings account to do the job right. The good news is that doesn’t have to be a stumbling block.

Home equity lines of credit, or HELOCs, can be a useful tool for a number of reasons, not the least of which is taking care of renovation projects at home. HELOCs are just as they sound: lines of credit that are delivered via the equity in your home.

How does a HELOC work?

In many cases, HELOCs are in a second lien position from a primary mortgage, which takes a first lien position. It is possible, however, to take out a first lien HELOC if there is not a mortgage already on the home. Many banks will loan up to a percentage of the home’s equity.

Case study

Let’s look at a simple scenario to figure out how this could go:

  1. Sean and Sara have consulted with their contractor and determined that they’ll need $80,000 to complete the work on their home.
  2. Let’s suppose their home is worth $200,000 and they owe $80,000 on their first mortgage.
  3. They are seeking $80,000 for their project. A first mortgage of $80,000 combined with a HELOC in a second lien position = $160,000.
  4. Borrowing $160,000 against a property valued at $200,000 creates an 80 percent loan-to- value scenario.
  5. Many banks differ in how much loan-to-value they will allow. This is an important question to ask any lender. If you don’t possess as much equity as our scenario above, but you’re working with a bank that allows a higher loan-to-value, you may still be able to obtain the loan.

Read the Fine Print

It’s also important to understand the terms, rates and closing costs associated with your HELOC. HELOCs can range from 1 year, 3 years, 5 years and even up to 10 years. Typically, HELOCs have a different rate structure than most fixed mortgages. HELOCs usually are floating rate loans that are margined off of the Wall Street Journal Prime rate. Some banks offer HELOCs directly at the prime rate, whereas others look to do prime + 1.00%, prime + 2.00%, etc. Borrowers also need to be mindful of appraisal costs and title work costs, as well as any bank fees that may be associated with taking out a HELOC.

Many HELOCs operate as revolving lines of credit, which means the borrower can draw up or pay down on the line at their discretion. It is common for HELOCs to have interest-only payments, which means that only the interest accrued for that period is made for payment. Borrowers usually have the discretion to pay down principal balances as they wish.

Borrowers are allowed to close a HELOC at any time, as long as their balance is $0. Many times they will close upon sale of the residence, regardless of whether a first lien mortgage is in place or not. While interest-only payments are common, it is highly encouraged for principal reduction to occur over the life of the loan.  This demonstrates appropriate usage of this lending tool.

In Part II of this series on renovation financing, we’ll discuss construction loans and how they can also be used for large-scale renovations.

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Cameron Puckett is a Greeneville, TN native who moved to Knoxville in 2003 to attend The University of Tennessee where he earned a degree in finance as well as a Masters of Business Administration. He has been in banking since 2007 and enjoys working with individuals and businesses to help them achieve their financial goals. He has served as President of Young Professionals of Knoxville and is actively involved in the Knoxville Chamber Ambassadors Program, the Rotary Club of Knoxville and Big Brothers Big Sisters of East Tennessee. Cameron is passionate about serving his clients and seeing his community grow and prosper.