What Is a First-Lien HELOC?

What Is a First-Lien HELOC?

A first-lien HELOC is a line of credit that replaces your existing mortgage. HELOCs are normally second mortgages, occupying "second position" behind your primary, or "first position" mortgage. If you were to default on your home loans, the first-lien lender is first in line for any possible future debt repayment. A HELOC that replaces your existing mortgage moves into first-lien position.

Example: Say your home value is $500,000 and you still owe $200,000 on your mortgage. You could open a first-lien HELOC for $300,000, pay off your existing mortgage and still have $100,000 available to borrow from in the form of a credit line.

Many people choose first-lien HELOCs for their access to equity and initial interest-only payments. They're commonly used for expenses like home renovations, investments or debt consolidation.

While first-lien HELOCs can help you tap into home equity, they do have several drawbacks compared to keeping your traditional mortgage.

Tip: A second-lien HELOC is a more common type of HELOC that leaves your primary mortgage unchanged. It might be helpful to consider a first-lien HELOC as similar to a refinance and a second-lien HELOC as an additional funding source. The credit line and repayment of both types of HELOCs function the same.

Traditional Mortgage vs. First-Lien HELOC

While a first-lien HELOC serves as a revolving line of credit, a traditional mortgage is an installment loan with regular monthly payments over a set term. As such, traditional mortgages are best for borrowers seeking stability, while first-lien HELOCs may be ideal for those seeking greater access to their equity. Here's a quick breakdown of the two.

How Does a First-Lien HELOC Work?

A first-lien HELOC functions like a credit card, allowing you to borrow, repay and borrow again as needed. First-lien HELOCs typically consist of two phases: the draw period and the repayment period.

During the draw period, which typically lasts up to 10 years, you can borrow funds up to your credit limit and may be allowed to make interest-only payments on the balance.

After the draw period ends, the repayment period begins, during which you can no longer withdraw funds and must start repaying both your outstanding balance and interest. This period usually lasts 20 years.

A HELOC's interest is calculated daily based on your outstanding balance. For this reason, it's a smart idea to repay whatever you can during the draw period, even if you're not required to.

First-Lien HELOC Requirements

To get a first-lien HELOC, you generally need to meet requirements in the following areas:

• Credit score: You can typically qualify for a HELOC with a minimum credit score of 680, though exact requirements for first-lien HELOCs vary by lender.
• Debt-to-income ratio (DTI): DTI compares your monthly debt payments to your income. Lenders use it to determine whether you'll be able to manage an additional loan payment. Different lenders have different DTI requirements, but usually set a maximum between 35% and 45%.
• Income verification: For a first-lien HELOC, lenders look at your income to help determine whether or not you'll be able to make manageable, reliable payments.
• Loan-to-value (LTV) ratio: First-lien HELOCs commonly require an LTV ratio of 85% or lower, meaning the amount you borrow cannot exceed 85% of your home's appraised value.

First-Lien HELOC Pros and Cons

First-lien HELOCs offer some benefits, but there are downsides to consider as well. Here's what to know before taking the plunge:

Should You Get a First-Lien HELOC?

Getting a first-lien HELOC can be risky if you're not on top of your finances. Keeping a traditional mortgage offers stability with predictable monthly payments, especially if it's a fixed-rate loan, allowing you to more easily budget over time.

Replacing your traditional mortgage with a first-lien HELOC introduces flexibility, but also risk. The ability to continually borrow up to your loan limit can lead to a cycle of ongoing debt if you're not careful. What's more, the variable interest rate means payments can increase unexpectedly, making it harder to manage your finances without strict budgeting.

That said, there are a few scenarios where it might make sense to replace your traditional mortgage with a first-lien HELOC:

• You have a high-interest first mortgage. If your first-lien HELOC rate is lower than the rate on your current mortgage, you could immediately start saving on interest.
• You're a financially disciplined borrower. First-lien HELOCs can be a great option for those who regularly budget and track spending.
• You plan on using your equity strategically. A first-lien HELOC can be a valuable tool for making smart investments and pursuing value-added projects like home improvements.
• You intend to pay off the loan quickly. The faster you pay off your loan, the quicker you can be debt-free.

How to Get a First-Lien HELOC

Getting a first-lien HELOC isn't as straightforward as applying for a traditional loan. To boost your chances of approval and secure favorable terms, it's important to take a strategic approach. Here are some tips to help you successfully obtain a first-lien HELOC:

• Look for specialized lenders. Not all banks and credit unions offer first-lien HELOCs. Specialized lenders may offer more competitive rates, flexible terms and streamlined approval processes.
• Improve your credit. Your credit score plays a major role in qualifying for a HELOC. It doesn't hurt to improve your score before applying.
• Create a payoff strategy. HELOCs are a revolving line of credit, and without a solid payoff strategy, it can be tempting to overspend and go deeper into debt.

Learn more: How to Improve Your Credit Score

Alternatives to a First-Lien HELOC

If you'd like to access your home equity but a first-lien HELOC doesn't seem like a good fit, there are a few alternatives you can consider:

• Cash-out refinance: A cash-out refinance replaces your existing mortgage with a new one, allowing you to tap into your home equity for a lump-sum cash payment. Cash-out refinances are sometimes used to consolidate debt and make home improvements.
• Home equity loan: Home equity loans are a type of second mortgage that allow you to borrow against your home equity and pay it back over time. Like cash-out refinances, home equity loans can be a good option for those seeking a large lump-sum payment.
• Personal loan: If you're looking to fund a one-time expense, consider getting a personal loan, which allows flexible borrowing and repayment options. Personal loans are often easier to get than HELOCs and may come with fewer fees.
• Reverse mortgage: If you're 62 or older, you may qualify for a reverse mortgage. A reverse mortgage uses your home's existing equity as collateral, and you won't have to pay it back as long as you live in your home.

Learn more: Home Equity Loan vs. HELOC: What's the Difference?

Frequently Asked Questions

Consider if a First-Lien HELOC Can Work for You

A first-lien HELOC can be a flexible and powerful way to leverage your home's equity, but it also comes with unique risks and responsibilities. Before moving forward, take time to consider how it fits into your overall financial plan. With the right strategy, a first-lien HELOC could help you reach your long-term goals.