One of the benefits of home ownership is the appreciation: Home values rise over time and you increase your equity through the reduction of your mortgage. Home improvements can also increase equity at a faster pace. Once you have a little equity, you might be tempted to tap into that equity through a home equity line of credit, commonly referred to as an HELOC. Here is a breakdown of the factors to consider before taking out an equity line of credit on your home.
• Access to cash. Access to cash without selling your home is one of the biggest advantages to a HELOC. The lender opens the line of credit similar to a credit card. You can make a draw on the account at any time and for any purpose. But make sure you understand the interest that can accrue and other pitfalls you may need to avoid.
• Easy and fast access. The loan approval process is much simpler and faster than a mortgage loan. Once the line is in place, you can draw on it, pay it back, and draw again for the term of the line. There is minimal paperwork, low closing costs, and most applications close in a couple of weeks instead of over a month. To get funds, you can make a bank transfer, write a check, or use a debit card.
• Interest only payments. Regardless of how you access the line, the rate remains the same, unlike credit cards which charge a premium for cash advances. It is a low-cost source of capital to finance home maintenance or home improvements.
• Low rates. HELOCs offer consumers rates as low as the Prime rate. Consumers typically find it easier to qualify HELOC for than a mortgage. Equity lines offer very affordable financing, at much lower rates than most other courses of cash. You can also put a line of credit in place before you need the funds.
• Low setup costs. Some banks may even waive the closing costs, giving you a line of credit in place with just your signature.
• Tax deductible interest. In most cases, you can deduct interest charges on your taxes, regardless of how you use the cash advance.
• Variable rates. Variable rates can leave long term balances subject to higher borrowing costs. Most lines of credit connect to the Prime rate and adjust the month after Prime changes. If the rate falls, your borrowing costs decline. However, when rates rise rapidly, you will find interest payments increasing as well. That 3% HELOC could become 9% or 10%. Unlike variable rate mortgages, which have maximum increases at each rate adjustment, HELOCS often leave you with little protection from rising rates.
• Line of credit to loan conversion. HELOCS, unlike credit cards, have a set time when the account will close. Most lines of credit have a draw period and a repayment period. During the draw period, you make interest-only payments on any outstanding balances; during the payback, the loan essentially converts to a variable rate loan. You can no longer make withdrawals and your required monthly minimums amortize to ensure full payoff by the end of the term. For example, if you have a 20-year loan, look for a 10-year draw and 10-year repayment. That can lead to a much higher second mortgage on the back half of the loan period. The interest rate often remains variable throughout the draw and repayment.
• Reduces equity. When you sell your house, you must pay off any remaining balance on the HELOC at closing. This requirement could leave you with lower profits, or require cash out at the closing if you do not have enough equity to cover realtor fees and seller closing costs.
• Approvals are more stringent than pre-2007. It used to be that lenders would give you a Prime interest rate for 100% of the home’s value, minus the mortgage and other liens. Not anymore. Banks typically calculate available equity in this manner: Let’s assume your home has a value of $300,000, and you owe $200,000, with the bank offering a maximum of 90%. You would qualify for a $70,000 HELOC. The calculation takes the maximum percentage equity before deducting any leins. In this example the calculation is: $300,000 X 90% - $200,000. Second homes may only get lines of credit for 50 or 65% of the value of the home and primary homes often cap out at 80 or 90% of available equity.
• Hidden fees. Banks often promote “No closing costs” to encourage applications. However, you may find there are fees for the appraisal, or closing costs as an initial draw on the line. Some banks have mandatory withdrawals at closing, mandatory auto drafts, annual fees, and other important terms laid out in the fine print.
• Requires self-control. Experts recommend only using an equity line for expenses that will raise the home’s value. If you lack financial self-control, a home equity line could worsen your financial outlook, instead of improving it. Easy access and low interest can tempt you to pay for consumer goods, take an exotic vacation, or pay off other outstanding loans.
• You could lose your home. An HELOC uses your home as collateral, and just like your primary mortgage, if you miss the monthly payment, the bank may foreclose on the home.
• Declining home values could leave you underwater. The Great Recession of 2007, reminded us that home values do not always rise with the tide. When values fall, you may have trouble refinancing, selling, or otherwise getting out of the property. Converting equity to cash, increased the risk financial loss if you need to sell before the market recovers.
Tips For Success:
• Use caution when drawing on the line of credit. Just because you can write a check, does not mean you should. Carefully consider each withdrawal, and have a plan in place to pay back the debt quickly.
• Read the fine print. Lines of credit vary widely across lenders. Rates and terms are not consistent. Before taking out the HELOC understand what you are getting. Does it convert to a loan, are there closing costs, mandatory withdrawals at closing, and other terms that might make the convenience of easy money less attractive.
If you are burdened with high amounts of credit card debt and are struggling to make your payments, or you’re just not seeing your balances go down, call Timberline Financial today for a FREE financial analysis. Our team of highly skilled professionals will evaluate your current situation to see if you may qualify for one of our debt relief programs. You don’t have to struggle with high interest credit card debt any longer. Call (855) 250-8329 or get in touch with us by sending a message through our website.