Home Equity Line of Credit
We like to describe HELOCS as being quite similar to a credit card, a giant credit card that is, you are able to use them as a revolving account. In essence, a revolving account allows you to borrow and payback as your needs and abilities warrant. For instance, if you receive a HELOC in the amount of $50,000, this entitles you to borrow any amount up to $50,000 at any point in time during the “draw period” and likewise repay or partially repay at any time during this period. If you have a balance outstanding at any point during a month you will be required to make a minimum monthly payment to the lender.
Typically, the interest rate you pay on a HELOC will be lower than that which you would pay on a credit card. The essential reason for this is a HELOC is secured by real property (your home) whereas a credit card is unsecured (personal guarantee). If you default on a HELOC, you could ultimately lose your home through a lender foreclosure. A similar default on a credit card will not negatively impact home ownership, but will take a serious toll on your credit rating.
HELOCS have variable interest rates which are typically tied to the prime lending rate plus or minus a margin. The interest paid on a HELOC loans is tax deductible with certain limits and restrictions set forth by the government. This tax deductibility feature is the result of the loan being secured by your home. Hence, it is a mortgage and as such the interest paid qualifies as a tax deductible expense.
In addition to the revolving account and tax deductibility features of this type of loan we believe perhaps the most beneficial feature of a HELOC is the security feature that it affords a borrower. In the event of an emergency or family crisis, these funds are readily available without the necessity of applications, questions and or explanations.
Along with advantages be assured there are disadvantages to HELOCS. A “giant credit card” in the hands of a fiscally irresponsible person is a catalyst for financial disaster. Thankfully, most borrowers do not fit this mold and as such, potential financial disaster from the misuse of a HELOC is not a norm but rather an extreme. We believe a much more serious disadvantage is the potential impact of the variable interest rates on HELOCS.
During the past few years, we have experienced historical lows in interest rates. HELOCS with interest rates of 4.00% were commonplace. However, look at where they are now and where they are likely to go. The 4.00% prime rate sounded and was good in 2003 and 2004. But, are you aware that the prime rate exceeded 10% during the last 5 years and that it exceeded 20% within the last 25 years?