If you have equity in your home, you can tap into it with an open-ended mortgage loan. This loan mimics what a credit card would do for you, just for a larger credit limit. The amount of your credit line depends on the value of your home and the amount of your first mortgage.
While it has the name ‘mortgage,’ this loan works much differently than your standard mortgage. We’ll look into it in detail below.
Obtaining the Open-Ended Mortgage
The open-ended mortgage application process works much the same as your first mortgage loan. You’ll complete an application and prove all of your qualifying factors. You’ll need to prove your income, assets, credit score, employment, and home value. You’ll also need to provide the outstanding amount of your current mortgage.
The lender will determine your eligibility based on your qualifying factors. There is not a specific guideline like there is for conventional, FHA, or VA loans. Each lender has their own requirements. In general, however, you’ll need:
- Credit score of at least 660, but many lenders require a 680 or 700 score
- Loan-to-value ratio of 80% or less
- Debt-to-income ratio no higher than 43% including all monthly debts
These requirements are dependent on the lender, though. Some will be stricter while others looser. Obviously, the higher your credit score and the lower your debt ratio, the more likely you are to get an approval.
How It Works
So how does an open-ended mortgage work? This is where the major differences begin. You apply for a specific loan amount, but you don’t necessarily receive that amount at the closing. Instead, the lender sets up an account for you to give you access to the funds. This is your ‘credit limit.’ You can use the funds as you see necessary.
For example, let’s say you have a $50,000 limit. You can take all $50,000 at once or you can let it sit in the account, using it as you need.
The loan will be broken into two phases – draw period and repayment period. The draw period is when you can use the funds. Let’s say out of the $50,000 you use $10,000 of the money at first. You would then pay interest on the $10,000 alone. Each month you would receive a statement that shows the minimum monthly payment you owe, which covers the interest on the funds you used.
You are not restricted to paying just the interest, though. You can pay as much as you want each month. As you pay down the principal, you can then reuse the funds. On the $50,000 example with $10,000 drawn, you’d have $40,000 left to use. However, if you pay back $5,000 of the $10,000 you borrowed, you would have $45,000 available for use.
Once you enter the repayment period, however, you can no longer draw the funds. This usually occurs after the first 10 years. The final 20 years of the loan consist of the balance amortized over 20 years with a fixed interest rate. You’ll need to check with your lender to determine if they offer a fixed interest rate on the loan, however. Some loans have an adjustable rate through the entire term.
The Benefits of the Open-Ended Mortgage
The open-ended mortgage has several benefits:
- Provides you with access to emergency funds should you need them in a pinch
- Only requires interest payments for 10 years
- Flexible qualifying guidelines
The home equity line of credit, as the loan is loan, provides you with flexibility. It’s especially helpful for borrowers that do not have an emergency fund set up. They can use these funds in the place of the emergency fund account. However, you have to have good enough willpower to not use the funds just because you have them.
The Downsides of the Open-Ended Mortgage
Of course, there are downsides to the open-ended mortgage:
- Many HELOCs have an adjustable interest rate
- You put your home on the line if you miss your mortgage payments
- You could end up underwater if your home’s value decreases
- It depletes the money you have to put in your own savings account
The HELOC is only for those that can carefully manage their finances. You should have a goal in mind as far as paying off the loan. Don’t just take the funds and pay the minimum payment each month. Have a clear plan not only for the use of the funds, but also repayment.
The open-ended mortgage can help you in many situations. Whether you need an emergency fund or you want to fix up your home, the funds are there if you have the equity in your home. Evaluate your options and figure out which loan suits you the most.