Home Equity Line of Credit

Overview:

Short on cash, emergency fund gone, and left with only credit cards. Many have been there, but let’s talk about a proactive approach if this situation was ever to arise.  

Purpose:

The purpose of this article is to discuss a Home Equity Line of Credit (“HELOC”). Let’s quickly describe the differences between a Home Equity Loan and a HELOC.

When you take out either a home equity loan or a HELOC, you are borrowing cash on the equity you have built up in your home (i.e. the payments you’ve made to date on your home vs. the total mortgage due). There are different amounts to what a lender will let you borrow, but basically this is a way to get that equity/cash out of your home and use for other uses.

A Home Equity Loan is an actual loan you get from a bank. This is a one-time cash payment that you receive and then will be charged a fixed interest rate along your repayments through the term of the loan.

Whereas a HELOC is a line of credit. In a HELOC, think like a credit card that you pay back only what you spend. The difference between a HELOC and credit card is the interest rates. As the HELOC has your home as a collateral, the interest rates are way less than a credit card. We got our HELOC at 5%, whereas a credit card interest rate could be as high as 29.99%.[1]   The HELOC interest can also get you a possible tax deduction whereas credit card interest will not get you a tax deduction.

Additionally, when you get a HELOC, the bank will typically give you checks which you can use to pay for anything. The amount available to borrow will typically be a large amount much higher than your typical credit card limit.

Risks:

Now any spend on a HELOC is another form of debt. If your house value falls and you must sell at a loss against your mortgage, don’t forget you will also have to pay off these loans as well. Also, the interest compounds, so while the interest rates might seem smaller than credit cards, missing payments or extending the terms over a long period of time, will cost you significant interest.

Taxes:

Up until the 2018 tax year, an individual could deduct the interest as an itemized deduction on a Home Equity Loan or HELOC, not matter what the cash proceeds were used for. Noted this was limited to a loan of only $100,000 and only if your total mortgage was less than $1,000,000. [2]

In 2018 tax year, the interest would only be deductible if used for home improvement to improve your home. [3]

Conclusion:

Having a HELOC available is a great way to get cheap credit if you should ever need it.  Here are some pros of why I use a HELOC;

  • The yearly costs are typically very low;
  • The interest rates are a lot lower than a credit card,
  • The interest in prior years was tax deductible;
  • You set the payments terms; and
  • You might be able to borrow a large sum of money depending on you home value to mortgage calculation which would be larger than your credit card limit.

I use my HELOC as short-term borrowing vehicle. This allows me to make payments without worrying about trying to make sure I have all the cash in my checking account. Usually, I use this for my federal income taxes due in April and my real estate taxes. This allows me more time to time market to move cash from my investments to pay off the HELOC, as the HELOC usually only charges a small interest amount on my borrowing when in a short time frame.

Action Plans:

Do you own a home? Is a HELOC for you? Here are some actions you can take:

  • Review your financial outlook, if you were to need cash right now, where could you get that cash from? How much would it cost you to get that cash (i.e. interest rate)?;
  • Check some local banks to see what their interest rates may be on Home Equity Loans and HELOC; and
  • Review more on HELOC, home equity loans and 401(k) loans on Finance First.

[1] https://wallethub.com/answers/highest-credit-card-interest-rate-2140660307/

[2] https://www.nerdwallet.com/blog/mortgages/interest-home-equity-borrowing-tax-deductible/

[3] https://www.nerdwallet.com/blog/mortgages/home-equity-loan-line-credit-pros-cons/

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