Does A HELOC Make Sense For You?
Now that home values have recovered in much of the country, home equity lines of credit, or HELOCs, have become relevant again.
Used carefully, HELOCs can improve the financial position of homeowners by helping them upgrade their properties, fund investments, lower their borrowing costs, make monthly payments more manageable or set up a financial safety net.
HELOCs are a lot like credit cards, but they have much lower interest rates. HELOCs are mortgages, secured by your home. That makes them a fairly safe investment for banks and a less expensive source of money for you.
HELOC For Home Improvements
Flexible, re-usable HELOCs are ideal for long-term or DIY home improvement projects, because you can withdraw money and pay it back, over and over.
If your goal is increasing your property value, your best renovations are those with the highest return on investment, or ROI. Find those projects on the annual Cost vs Value Report, published by Remodeling Magazine.
Note that if you need a large lump sum for a remodeling contractor, a fixed home equity loan might be a better choice. Its rate and payment does not change, and that makes budgeting easier.
HELOC For Investment
HELOCs can provide cheap money for investing. If you can borrow at three percent and invest at eight percent, that’s sort of like getting free money. Homeowners use their equity to buy stocks, make down payments on rental homes, purchase art or collectibles, or start businesses.
The downside of using a HELOC for investment is that if the investment does not pan out, your home is potentially at risk. When investing with a HELOC, the loan is only as good as the investment behind it.
HELOC for Lower Rates
If you have unsecured debt, chances are you’re paying a significantly higher interest rate than you’d be charged with a HELOC. You can reduce your interest rate by replacing your unsecured debt with secured home equity financing.
With the average credit card interest rate at 15.81 percent, there’s lots of room for improvement with a home equity loan.
Understand, though, that if you repay the new loan over a 15 year term, your overall cost could be higher even at a lower interest rate. If your goal is to pay less interest, pay down the HELOC as fast as you can.
Lower Payments From A Home Equity Line Of Credit
Many who try debt consolidation do it to make their monthly payments more manageable. A HELOC can make that happen in two ways – first, by offering a lower interest rate, and second, by stretching out the repayment over a longer term.
If you owe $20,000, for instance, a typical credit card payment at 15 percent is $450. A 15-year HELOC payment at 3.0 percent is $138. That’s a lot of breathing room.
However, as noted above, stretching out the repayment could result in more total interest expense. The other potential downside is the high failure rate of debt consolidation programs. Don’t risk your home without getting some financial counseling and learning to live within your means.
Creating A Safety Net
If your income or expenses are unpredictable, consider setting up a “just in case” HELOC – it’s relatively inexpensive to do it, with fees ranging from zero to a few hundred dollars.
Why set up a HELOC now if your finances are fine? Because, as Bob Hope famously said, “A bank is a place that will lend you money if you can prove that you don’t need it.” A cash crunch can happen to anyone, so don’t wait until it’s too late.
You don’t want to be self-employed and unable to make payroll because a client’s check got “lost in the mail.”
If you own a vacation rental, it might be helpful to have backup cash for the slow time of year.
And if you’re a seasonal employee, you can experience cash flow problems even if you earn more than enough to live on. If your income fluctuates from summer to winter (or week to week), an emergency HELOC can protect your credit rating and your lifestyle.
How To Shop For A HELOC
HELOC interest rates, terms and costs can vary widely between providers.
HELOC rates are variable — they’re based on some sort of index, often the Prime Rate, plus a margin. Many HELOCs feature lower introductory rates, but you should know how they will change over time.
Some HELOCs come with prepayment penalties in exchange for more attractive interest rates, and others may have annual fees or inactivity fees.
Read the terms carefully, compare quotes from competing lenders, and choose your best deal. Today’s low rates and costs make good HELOC solutions even better.