We’ve all heard the stories about people, before the 2008-’09 financial crisis, using their homes as “ATMs.” I’m talking about homeowners using the equity in their homes to pay for luxuries – jewelry, vacations, even cosmetic surgery.
We were talking recently about his relationship with his bank. And when I asked him what questions he asks whenever he’s vetting a new bank, his answer intrigued me.
That’s poor financial management, and a lot of those folks got themselves in real trouble.
Today, most homeowners seem to have learned that lesson. I rarely hear about abuse of home equity lines of credits (HELOCs) or home equity loans anymore. Instead, when homeowners do take out a HELOC, too many of them use it solely as an emergency fund.
But this approach many not be the wisest choice for your money, either. There is, in fact, a middle ground between abusing the credit your home equity affords you and using it wisely.
What Is a HELOC?
A HELOC is different from a home equity loan, in which you get a lump sum amount, then pay it back according to a schedule. A HELOC makes a percentage of your home’s value available for five to 10 years, and its interest rate adjusts with the market (meaning they’re usually very low). When it expires, you only pay for what you’ve used – then it disappears with no additional expenses.
But, like a home equity loan, any interest you pay on a HELOC is treated like mortgage interest, which means it’s tax-deductible. Remember to consult your tax advisor when it comes to tax-deductibility.
Any loan or line of credit carries some risk, and a HELOC, for which you use your home as collateral, is no different. But if you are savvy and conservative, a HELOC is a safe and secure way to pay for a number of life’s major expenses. Let’s take a look at a few of them…
Because the interest rates are usually lower than those on student loans, using a HELOC to pay parts of your child’s college tuition could be a good option. Compare interest rates and closing costs to see if a student loan or a HELOC is cheaper for you.
HELOCs were designed to be used for home repairs and renovations. And that’s still the primary reason homeowners take them out. However, we recommend you use a HELOC primarily on improvements that increase a home’s value. That way, any interest you pay will return to you when you sell your home.
A HELOC is also good for financing essential repairs that may not raise the value of your home but will upgrade its safety and/or structural integrity. In this case, I’m talking about fixing a leaking roof or replacing faulty wiring.
For other home improvements, such as interior design and landscaping, tap your cash savings (though not your emergency fund). Or, put it on your credit card and pay it off at the end of the month. That way you can insure the equipment you buy — and pick up some points.
Everyone should keep an emergency fund to cover unexpected health bills, car repairs, and home repairs. Where you keep that emergency fund depends on your situation and financial philosophy. Some people believe that any money that isn’t “working for them” is useless. They keep their emergency fund in an easily accessible interest-paying savings account.
However, the interest rates on savings accounts are pretty measly these days. And so, you might be better off piling most of your cash into a stock market index fund. It’s not very sexy, but it earns more than a savings account. Then, use your HELOC as your emergency fund.
Besides what you pay off at the end of every month, do you have any credit card debt? If so, get rid of it. Use your cash to pay off what you can, and then pay down as much as you can of the rest using a HELOC. Home equity lines of credit charge much less interest than credit cards, so you’ll be saving money. Plus, unpaid credit cards hurt your credit score and, therefore, your chances of getting loans in the future.
If you consolidate debt using a HELOC, you’ll get out of debt faster thanks to those lower interest rates. Plus, you’ll essentially be paying yourself rather than Visa or MasterCard.
If you’re ready to apply for a HELOC, or to talk more about the best ways to use a HELOC you already have, please contact us.