Pros and Cons of a Home Equity Line of Credit (HELOC)

Pros and Cons of a Home Equity Line of Credit (HELOC)

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Transcript

What are the advantages and disadvantages of having a home equity line of credit? First, a home equity line of credit offers a lot of flexibility. One, it has a very low payment, an interest only payment. That can also be a disadvantage depending on how you treat it. If things were to get tight at the end of each month and a surprise came about, what you’re required to make is going to be substantially lower than what a typical mortgage is. But keep in mind, if you make that minimum payment, you’re on a treadmill. You’re not going to get anywhere.

Also, it’s open-ended with simple interest. It allows you to deposit 100% of your income with confidence that you can get that money back out to pay your bills. What’s left over is sitting in there driving down the average daily principle balance, which drives down the amount of interest that you pay, and ultimately gets it paid off much, much faster than a mortgage.

A huge advantage with a home equity line of credit is no closing costs. Typically banks don’t charge any type of lender fees and they will even compensate you for your title fees. Now, it depends on what state you’re in and how large your loan is but if you’re around the 0,000 to 0,000 loan amount, you can expect the bank to pay all of your fees and not include them in loan like typical mortgage lenders do. We’re talking actually pay it on your behalf. A lot of banks don’t even require an appraisal. There’s never mortgage insurance with a home equity line of credit. It doesn’t matter if you’re borrowing 85, 90, or 100% of the value of your home. A home equity line of credit never has mortgage insurance.

In some of the disadvantages of having a home equity line of credit is really not the product itself. It’s really the person using the product is a disadvantage. What I’m talking about there is discipline. What are you doing with your money now? You’re putting all of your money into a checking account. All we’re asking you to do is to replace your checking account with your home equity line of credit and you’ll be just fine. It’s discipline. That is the disadvantage of having a home equity line of credit. It’s folks not actually following through on that. If you don’t follow through on it, it’s no better than having a mortgage. It’s not worse, but it’s no better.

Another disadvantage is if you actually do perform the strategy, you’re going to find that you’re going to have access to a large amount of equity pretty fast. What are you going to do with that equity? Are you going to leave it in there and continue to pay off your debts or are you going to cash out to go buy an S-Class Mercedes? You’re buying a liability, not an asset. I am an advocate of pulling money out of your home equity line of credit to buy things that are assets. In fact, very specific assets. Dividend paying assets.

Those are the disadvantages of having a home equity line of credit. There is a perceived disadvantage of having a home equity line of credit because the rates typically are variable meaning they can change at anytime and go up or down. The reason why I say that’s perceived, it depends on how you treat the home equity line of credit. If you treat it like it’s your checking and savings account, and your cash flow positive, you’re interest rate immune. What that means is, you’re actually reducing the principle much faster than the rise of interest rates. There are quite a few banks that offer fixed rate home equity lines of credit so you don’t even have to worry about that if you didn’t want to.

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Watch more Home Finance 101 videos: http://www.howcast.com/videos/418268-How-to-Get-Equity-from-Your-Home

If you have paid off a good portion of your house and its value has appreciated, and you find yourself in need of some extra cash, you may consider taking out a home equity loan.

Step 1: Assess your risk
Assess your risk. Borrowing against your home equity depletes your investment, and reduces the cash you can take out in an emergency.

Step 2: Learn the tax rules
Familiarize yourself with the tax rules governing home equity borrowing. To deduct interest you have to itemize, which cannot be done if you have too few deductions.

Step 3: Consider your borrowing options
Consider your borrowing options. A home equity loan is secured by house to the extent the fair market value exceeds the debt incurred when you purchased it. A home equity line of credit is a form of revolving credit in which your equity in your home serves as collateral.

Tip
Consider applying for a reverse mortgage loan if you are at least 62 years of age and occupy the home as a principal residence. A reverse mortgage is a loan against your home that you do not have to pay back as long as you live there.

Step 4: Decide on a loan type
Decide whether a loan or line of credit will best meet your needs. In general, a loan is best for short-term borrowing or when you need the money in an emergency. A line of credit is best if you want to lock in a low interest rate.

Step 5: Apply
Apply for the loan or line of credit. Be careful about signing up for application or appraisal fees. If you have good credit, you should not have to pay these fees to borrow against your home. With the appropriate steps, you’ll secure some cash — and maybe even use it to increase your home’s value.

Did You Know?
Some experts estimate that less than a third of home equity borrowing is used for investments, with the rest being used for debt consolidation, vacations, or purchases that depreciate quickly.
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