Pay down mortgage or current HELOC before applying for new HELOC?

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My current HELOC will expire at the end of 2014, and I want to apply for a new one in about a year (for a rainy day fund). Out of curiosity, I applied for a HELOC 2 years ago, and the bank offered a 7.5% rate, about 2% more than my current rate, so I declined. They said it would have be lower, even down to 3.5%, if my equity had been higher. My house value is probably around $260,000, my primary mortage principal is now $146,000 (was $170,000 when I applied last), and current HELOC balance is $20,000. Lately I've been paying an extra $1,500 per month toward my mortgage principal and/or HELOC balance. My credit is fine.

To qualify for the best HELOC rate when I apply in 2014, between now and then should I apply my monthly extra $1,500 to (1) mortgage payments, (2) to pay off the old HELOC, or (3) some combination of (1) and (2)? My guess is (1), since the HELOC bank will care more about my home equity than the fact that my old HELOC isn't paid off (?). I think a lot of HELOCs require an initial draw of at least $10,000 anyway. Does all this make sense?

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Equity = value - loans
loans = primary + HELOC

Paying either loan has the same effect on equity. Since your HELOC has a rate of 5.5%, and your primary mortgage has a rate lower than that since you are on FW, it makes more sense to pay down your HELOC.

gordon72 said:   My current HELOC will expire at the end of 2014.Are you sure? Most HELOC's have renewal options, and some that don't, get renewed anyway. I'd check with my lender first.

As for your payoff strategy, LTV is key. My most recent HELOC gave the best rates to LTV < 65%. That includes the full amount of the HELOC, not just amounts outstanding. Don't focus on that initial draw either. You can take it and pay it right back in most cases.

It depends on what your goal is as far as the amount of the new HELOC. Using your current numbers (ignoring normal principal payments and future appreciation/depreciation), assuming your future lender will approve a HELOC with a Total LTV of 80%, and assuming you pay down $18,000 ($1,500 for about a year), here is what each would look like if you only did one of the other:

Current 1st	$146,000.00	$146,000.00 
Paydown		$18,000.00	$-   
Current 2nd	$20,000.00	$20,000.00 
Paydown		$-		$18,000.00 
FV 1st		$128,000.00	$146,000.00 
FV 2nd		$20,000.00	$2,000.00 
Value		$260,000.00	$260,000.00 
-80% of V	$208,000.00	$208,000.00 
=HELOC Limit	$80,000.00	$62,000.00 
Payoff 2nd	$20,000.00	$2,000.00 
HELOC Balance	$20,000.00	$2,000.00 
HELOC Avail	$60,000.00	$60,000.00 

In either case, you will have $60k of equity available, it just makes the options for the new HELOC balance/limit, and more importantly rate, different. IMO, it will be better to pay down more on the first. You should be able to get the best rate at the lowest LTV you can go. The more equity you have between the first mortgage balance and the value, the larger your new HELOC can be under a certain LTV (say 80%, or maybe 70% for a better rate) while still giving you a large enough available limit for your rainy day fund.

Of course you have to consider your current rates and your current available HELOC as well. Is it maxed out and would you rather dump money into that that you can still access in the next year? Is one rate much higher? If you are comfortable with the rates you are paying now, you could even do neither and hoard the money to have available to paydown either loan when the time comes to apply again, based on the current value and HELOC options at the time.

Now that I've typed all this...assuming your current HELOC is a higher rate, it would make the most sense to put it all to the HELOC. Save on interest now, and then in a year from now, you can advance that $18k (+) to paydown the 1st if that gives you better options on the new HELOC. Your only concern there would be your HELOC lender for some reason closing your line early.

I think BingBangBlaow's analysis anwered my question. By paying down my mortgage an extra 18k instead of my current HELOC over the next year, the bank will subtract only $128k from the 80% of value $260k instead of 146k when they calculate the HELOC limit, rate, and LTV. I wasn't sure if they would subtract $146k in either case, since both the primary mortgage and HELOC balance are loans against the home value. But that would like counting the $20,000 twice, since it also will be a portion of the available new HELOC.

My fixed mortgage rate is 3.5%, lower than my current HELOC rate of 5.5%, so as mogg noted I'll be paying higher interest on the old HELOC if I pay down my mortgage instead. But it's only for a year, totalling around $360 more, and it's the trade-off for getting a lower interest rate on the new HELOC, which will last maybe 10 years or more. BTW, my old HELOC was for 10 years with one possible 5 year extension, which I've already used, and the limit is $57,000.

Well as I said in my last paragraph, just pay down the HELOC over the next year, and then in 1 year, advance the $18,000, use it to pay down the 1st, then apply for a new HELOC. Save on interest now and hopefully later with the new HELOC. If you're comfortable that the current line will remain open, you could put all available funds to the HELOC, effectively earning 5.5% on them, then advance some of the available limit in 1 year's time to pay down the 1st. If your 1st is fixed, you'll want that balance to be as high as possible in the end (because your HELOC will most likely be at or above 3.5% and variable). So you can decide next year what you should pay your 1st down to in order to get the best HELOC at that time.

I personally feel that rather than taking out a new HELOC, it will be better if you could combine both the existing loans into one and then take a cash out of the equity that you have in the property for a rainy day fund.

Now I get what you mean in your last paragraph, BingBangBlaow, good idea. I'll pay down the HELOC instead for a year to save interest, and then after a year re-borrow from the HELOC to pay down my mortgage before applying for the new HELOC. I suppose at that time I could could pay down the mortgage by any amount up to my current HELOC limit (e.g. $30,000 instead of $18,000) to minimize the interest rate and LTV on my new HELOC, but as I you say, I'll have to keep in mind the higher interest and variable rate of the new HELOC versus the mortage interest.

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