Home Equity Line of Credit: Is it Right for You?

The home equity line of credit (HELOC) is a unique financial planning tool that allows homeowners to borrow against property for cash. HELOC offerings are structured to allow for consumer flexibility, while also enabling banks to turn sufficient profits. The product does expose savers to distinct risks.

Home Equity is Ownership

Home equity describes financial ownership and is the difference in price between a property’s market value and mortgage balance. We build home equity through mortgage amortization, or pay down, and property value appreciation. In recent years, easy access to credit and cheap money have powered a hot market.

Borrowers hire professional appraisers during the HELOC application process to price out real estate collateral. From here, bankers will subtract the outstanding mortgage balance away from the home’s appraised value and calculate a credit limit. Expect to borrow 85% of your home equity.

HELOC Terms and Conditions

Home equity lines of credit are revolving loans, similar to credit cards. The HELOC is distinct from a home equity loan, which is a lump sum of cash to be repaid.

Consumers may write checks or present cards to purchase goods and services, up to the credit limit. HELOCs charge interest at variable rates – in line with the economic environment. The Federal Reserve has been aggressively driving rates higher post-pandemic, in an attempt to stifle white hot inflation.

Home equity lines of credit do charge low interest rates relative to credit cards. A credit card is unsecured debt, which is only backed by your good faith promises to make principal and interest payments. The HELOC is backed by real estate collateral, which lessens financial risks for big banks.

Banking Fees and Closing Costs

Banks collect interest and fees as compensation for offering the HELOC product. Banks may charge fees and closing costs for arranging the appraisal, reviewing the loan application, check processing, and servicing the account. HELOC closing costs may be between two and five percent of the loan amount, with $50 in annual fees.

Home equity line of credit interest may be deductible from your taxable income, if the money is spent to purchase, build, or improve your primary residence.

HELOC Financial Strategies

Regularly monitor your credit report and score as part of a financially productive lifestyle. The Fair Credit Reporting Act outlines your rights as a consumer.

Home equity lines of credit are best used for large transactions of $10,000 or more due to closing costs and fees. Some consumers take out home equity lines of credit to refinance expensive credit card debt.

Sophisticated investors may leverage the HELOC to buy into assets to generate greater long-term wealth, such as a start-up business or higher education. Horatio Alger himself would be quite proud of friends and family who took out second mortgages to buy into Apple and Berkshire Hathaway shares of stock.

Financial Risks and Home Foreclosure

We highly advise against tapping into home equity for discretionary, consumer spending. Spending HELOC funds to buy automobiles, vacation packages, jewelry, and designer clothes will open up a financial death spiral of lifestyle creep, larger debt levels, and crushing interest payments.

If anything, consumer spending should be reserved for credit cards. Consumers seeking out lower rates may simply call around to card companies to negotiate deals for balance transfers and force the banks to earn business.

Home equity lines of credit, again, are secured loans backed by real estate collateral. The bank will foreclose upon, or seize, your home to auction it off for cash to make good on the loan, in the event of default.

For this, Onyx Investments rarely recommends home equity lines of credit as suitable vehicles for prospects and clients.