What is a First-Lien HELOC Mortgage?

Ever hear of the term HELOC loan or HELOC mortgage before? HELOC stands for a home equity line of credit. Normally it’s known as a “second mortgage." As a homeowner, you can leverage your home as collateral for another loan, giving you access to significant funds in the process. Because it’s often a second loan, the term and repayment schedule remain separate from your mortgage.

Something you may not realize — a HELOC can also be written in the first lien position, so there is no second mortgage and no separate terms to worry about.

How does a first lien HELOC work?

A first lien HELOC is a line of credit and mortgage in one. They are considered open end mortgages. It often works by replacing your existing mortgage, taking over as first lien or first mortgage. But unlike a traditional mortgage, it also works like a checking account, similar to a home equity loan. Borrowers are able to apply direct deposits to the loan principal — reducing mortgage interest and home loan term. You can also withdraw cash (in the form of a home equity loan) for the 30-year loan duration without having to refinance.

People choose a first lien HELOC to pay homes off sooner and build equity faster, while having the ability to draw out funds as they are needed.

Not a homeowner yet? Not a problem. Another advantage to a first lien HELOC, specifically the American Financing All in One Mortgage (first lien HELOC), is it can be used for new home purchases. It’s home financing and personal banking combined into one fluid financial tool.

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HELOC requirements

A lender will look at your home equity, loan-to-value ratio (or LTV), and credit score before making a decision on your HELOC application.

Let's start with home equity. You can calculate this figure by taking the current market value of your home and then subtracting what you owe on your mortgage. So if your residence is currently worth $400,000 and you owe $200,000 on the loan, you have $200,000 in home equity.

But don't think your lender will allow you to borrow the full amount of equity. Instead, they'll use your LTV to determine what portion of these funds you can borrow. LTV is found by dividing the amount of a mortgage by the home's value.

This means that, in the example above, your LTV is 50%. The question at this point becomes how much will your lender allow you to borrow.

Related: What is an Interest-Only HELOC?

How much HELOC can I get?

A HELOC usually provides anywhere from 80%-90% of your home’s value in cash, less the balance remaining on your mortgage. It’s adjusted based on your creditworthiness and ability to pay off debt.

Whether in the first or second mortgage position, HELOCs can be a potential money management tool for paying large expenses such as home renovations, high-interest credit card debt, medical bills, or even college tuition or student loan debt.

Let’s try an example. Say your home is worth $400,000 with a remaining balance of $200,000 on your first mortgage, and your lender is allowing you to access up to 80% of your home’s equity:

$400,000 x 80% = $320,000
$320,000 - $200,00 = $120,000, your max HELOC available after paying off your existing mortgage

It’s important to know that most HELOCs have variable interest rates so they’re subject to change over time. This is dependent on increases or decreases in benchmark interest rates, such as the prime rate. Rate adjustments can be frequent, and they can increase significantly during periods of inflation. To calculate your rate, lenders start off with the prime rate, then increase it depending on your credit profile.

Related: How fixed-rate HELOCs work

Should you replace your mortgage with a HELOC?

Just because your neighbor may have used a HELOC to pay off their mortgage doesn't mean you should follow suit. Many borrowers find themselves playing catch-up on their HELOCs for years. So make sure you understand the ins and outs of this loan before moving forward with your own.

Have questions about a potential HELOC as it relates to your financial situation? Spend some time looking for banks that offer HELOC in the first lien position. There are a number of reputable first lien HELOC lenders that can help.

Is a home equity loan a better option?

Many confuse HELOCs with home equity loans. While both are considered second mortgages, a HELOC is simply more flexible, letting you use your home’s value in the exact amount you need. On the other hand, a home equity loan provides a lump-sum withdrawal.

Another difference: home equity loans are usually issued with a fixed-rate interest charge which prevents any surprise increases in future monthly payments if interest rates were to rise.

Is a cash-out refinance a better option?

You can accomplish similar (HELOC) benefits by considering a cash-out refinance. A cash-out refinance works by writing your existing mortgage into a new mortgage at a higher amount (depending on available equity). This allows you to pay off your current mortgage and receive the difference between the two loans in one lump sum. So you only have one mortgage instead of two, and instead of receiving access to a line of credit, you receive your funds all at once.

Another difference between HELOCs and a cash-out refinance is the way your interest rate works. You’re not stuck with a variable rate as you’d have with a HELOC. Rather you can choose between a fixed-rate or an adjustable-rate mortgage.

Researching loan programs is a great start to understanding loan benefits and disadvantages. Yet, an even better approach is to speak with an expert regarding what makes the most sense for your financial goals.

HELOC down payment

It's possible to use a HELOC as a down payment on your next home. This strategy involves tapping into your current home's equity and carrying multiple mortgages at once. Not all borrowers will benefit from a HELOC down payment, which is why we recommend working with a lender who has your best interest in mind.

Other ways to pay off your mortgage faster

Refinance into a shorter term

Today's historically low rates make now the perfect time to refinance. You could save hundreds of thousands of dollars by refinancing from a 30-year mortgage into a 15-year mortgage. Just imagine how incredible it would be to own your home in half the time!

Make extra principal payments

There's nothing wrong with paying extra principal on your mortgage whenever you come into some extra cash. In fact, doing so regularly could knock down several years of your loan term. Financial experts suggest eliminating high-interest debt and building a well-padded savings account before putting additional funds toward your mortgage.

Get rid of private mortgage insurance (PMI)

PMI is what protects your lender in the event you can no longer make your mortgage payment. But did you know that you can have your PMI removed once your balance drops below 80% of the home's appraised value? That's more money you can use every month to pay off your mortgage!