If you own a home with a decent amount of equity than you should open up a home equity line of credit (HELOC). Ill do my best to tell you why.
A home equity line of credit is taken out against the value of the home minus the mortgage you currently have.
As an example:
House is worth $175,000 and you owe $125,000 on your first mortgage. You have $50,000 in equity in your home. This isn’t to say a bank or mortgage company will lend you up to 100% of the value of the home as many banks only go up to 80%.
Some banks and mortgage companies would lend up to 125% of the value of the house during the first refi boom and lost their butts when people foreclosed. Things have changed in that regards. If you have equity and can find a bank to open a HELOC with than this is why you should get one.
When To Get A HELOC?
I would make the argument as soon as possible.
Did you just buy a house and put a 50% down payment? Call the bank back up and say you want a HELOC up to 80% of the value giving you 30% to have available.
Reason being is you never know when you might need cash fast. If you lost your job than how are you going to get approved on a new HELOC? You won’t.
I’d also make the argument you need to get a HELOC up to the highest amount the bank will give you. Again, you never know. You only pay on what you borrow so if the balance is $0 than you pay nothing.
Need money to pay off debt? Use the HELOC.
Need money for home improvements? Use THE HELOC.
Need money in case of an emergency? Use the HELOC.
Need money to pay for your kids college tuition? Use the HELOC
Need money to buy stocks or flips homes? Use the HELOC.
Since a home equity line of credit is a loan against your house you get to write off the interest that you pay. You don’t get to write it all off but every bit helps.
If you are an investor a HELOC should be considered cash. Tap it any time a great deal comes around. Get out the checks for your HELOC and write a check that day.
Thats the beauty of having a home equity line of credit. Its there when you need it. If you don’t need it then it just sits there waiting for you to use it.
How Do HELOC’s Work?
Adjustable Rate – Interest rates are tied into the Prime Rate controlled by the Federal Reserve. Every time you hear “The Fed is raising (or lowering) rates” your payment will be affected. Some banks offer fixed HELOC’s but they are few and far between. The adjustable interest on the home equity loan is the trade off for the flexibility of the loan.
Interest Only Payments – HELOC payments are based on a 30 year amortization schedule with the first ten years being a interest only period. This means you are only required to make interest payments on the amount you borrowed for the first ten years.
Pay more to bring the principal down when you can which will in turn bring down the required interest only payment. After 10 years the HELOC changes into a 20 year loan where you have to pay down the balance. Don’t like the new loan? Get a new HELOC.
Closing Costs – Are way cheaper than a first lien mortgage. In most cases less than $500. Most banks will not charge you the costs (most of it being an appraisal) as long as you keep the HELOC open for three years.
Fees – Most banks will charge a $50 annual fee to keep a HELOC open.
Using A HELOC
Depending on where you get your HELOC you will probably be given checks, a debit card, or both. If its with your local bank they will probably give you the ability to transfer funds from the HELOC to your checking account. Makes it easier this way to track where the money is coming and going. Some banks might make you call them and they will overnight a check.
Tips & Tricks
One of the coolest features of a HELOC is a little trick you can do to help pay down your bills or the balance on your mortgage. There are a couple companies that sell a similar product called a Money Merge Account. Ill show you how to use your HELCO just like it for free.
On the HELOC you pay little interest on big amounts. Example: $125k 30 Year Fixed Mortgage at 6% has $750 monthly payments where $625 of that is interest. So only $125 goes to pay down the loan. Over one year your balance will go down $125 x 12 months = $1500.
Lets say one month you write a check from your HELOC for $2k towards one months payment on your first mortgage. Your payment is $750 so $1250 went on top of the loan to pay down the first mortgage balance.
That $2k is now a balance on your HELOC where your payment (I’ll use 7%) is $2000 x 7% = $140 interest in one year / 12 months = $12. What you effectively did was transfer a lot of interest from your first mortgage to the HELOC.
You basically are going to double the amount of principle you pay off on the mortgage every year. Which in the long run will save you in the tens of thousands of dollars in interest. When you get your HELOC bill the next month all you have to pay is the $12 but you should pay $750. Pretty cool huh!
All in all the HELOC gives you a ton of flexibility with your finances and can be considered your emergency fund in tough times. These are not to be confused with a fixed second mortgage which is basically a loan. A HELOC is accessible money to be used whenever you seem fit.
I have one with my house and plan to keep it open for the foreseeable future.