When it comes to home ownership and home purchasing, the world of finance is much more complex than just a plain old conventional loan. There are all kinds of products out there that can utilize your home’s value (equity) for other purposes. This article will be about HELOCs or Home Equity Lines of Credit. But let’s start with this basic concept. When you own your home, it is an investment. And, just like other investments (like the stock market), the value fluctuates. Generally speaking, real estate appreciates in value. The pace of the appreciation varies and occasionally it drops but in general, it goes up. The logical explanation is that our population grows and “they don’t make more land”.
The majority of people that own a home have financed it with a mortgage. A bank loans them money at a certain percent interest and they pay it off over time. Most mortgages are for 30 years but you can get them for just about any time frame you like– in some areas, even longer than 30 years. The difference between what you owe and what it is worth is called equity. Your equity grows in two ways, you pay down the debt and simultaneously, hopefully, the value of the property goes up. Of course things can affect this growth–not taking care of the home, market fluctuations, taking out more debt against the house to name a few. For some, the idea of sitting on a huge chunk of equity means there is an opportunity to do something with it. Sometimes folks want to build onto a house or renovate a portion of it. Sometimes people want to take that chunk of equity and pay off other debts that are at a higher interest rate. Sometimes they want to put that equity towards purchase of another home–vacation home, rental home, home for their kids, etc.
The easiest way to access that equity is through a home equity line of credit (HELOC). Basically, a HELOC is a revolving debt against the equity of the home. Works like this, you have $300,000 in equity. The bank will allow you to open a HELOC for a certain percentage of the equity–usually it is figured by a total amount of debt to value on the house (90% total debt between the HELOC and the primary mortgage) and often the bank will cap the total of the HELOC. So let’s say they let you take a $150,000 HELOC out. If your primary mortgage pay off was $200,000, You now have the ability to be in debt a total of $350,000. BUT, the HELOC is not automatic. If you never use it, you owe no interest or payment on it and your total debt doesn’t change. Usually, if you do use it, you have a period of time where your required payment is interest only but you can pay as much of the principal as you want, no prepayment penalty. Interest rates are typically pretty reasonable (more so than credit cards) and the money is pretty easy to access. Some even have their own debit cards or checkbooks. The best part is that closing costs on these are typically very low. Some institutions don’t charge you anything at all. Much cheaper than cashing out in a refinance.
There are a few down sides. Rates fluctuate, so in an environment like we have now, the rate is going to go up which means that your payment will go up. Also, with the required payment being interest only and the ease of access to the funds, some people find themselves in a lot of trouble with these tools. You certainly have to be disciplined.
I know all this is probably SUPER basic but it is good to recap those basics sometimes. If you have questions about HELOCs, give me a shout. I’ve used them successfully several times for several different projects. There are some really good ones out there I can direct you to.
Originally published on November 22, 2022.