Home equity line of credit pros and cons
Photo courtesy of American Advisors Group, aag.com
As a result of the coronavirus, many families are facing both short-term income uncertainty and uncertainty regarding the future value of their asset holdings.
One way to provide more stability regarding access to assets at a reasonable cost is a home equity line of credit (HELOC).
Individuals who have substantial equity in their primary residence are generally able to obtain a line of credit, which generally covers 20 years in which, during the first 10 years or so, they have the flexibility to borrow up to their credit limit. After that, they are required to repay the outstanding balance.
A number of pros
There are several advantages associated with HELOCs.
1. Low interest rate: Most rates are based somewhat on the prime rate, which is now 3.25% as the base. Borrowers with the best credit ratings may be able to obtain an interest rate lower than prime. Most borrowers will borrow at a rate of prime plus a specified additional rate based on their overall credit rating, the stability of their income and the amount of home equity. For most individuals, the interest rate will be much lower than other loan options.
2. Flexible choices: Most financial firms allow borrowers the choice of fixed interest loans or variable interest rates, generally based on the prime rate.
3. Flexible loan amounts: One of the most favorable advantages of the HELOC is that during the first 10 years, you can borrow as much or as little as you need up to the limit of your credit line. However, some lenders will ask you to initially borrow a specified minimum initially. This feature is very useful if there is uncertainty regarding the amount of loans you will need for the first 10 years.
4. Flexible repayment options: In general, assume you can repay the outstanding loan amount at any time of your choice.
5. Low (or no) initial closing costs: Closing costs for HELOCs are much lower than for either traditional home mortgages or fixed home equity loans. Some do not have any closing costs. However, financial institutions that don’t have any initial closing costs will require you to pay their closing costs if you close the account within a specified period, such as three years. However, even in this case, the closing costs would be much lower than other types of home loans.
6. Low (or no) monthly charges: Many financial institutions have no recurring monthly fees. Even those that do, the fee is generally modest.
7. A tax advantage: If you do use the loan to improve the property, you may be able to include the interest cost as part of your itemized deductions.
A few cons, too
There are also some possible disadvantages.
1. Possible foreclosure: If you are unable to meet the required minimum payments, the financial institution can foreclose on your home. Accordingly, you should not borrow more than you can afford to repay.
2. Possible future payment increases: If you borrow using variable interest rates, such as the prime, if interest rates increase in the future, your required monthly payment will also increase. Interest rates are now at historically low levels, so it is likely that over the term of your loan, interest rates will increase.
3. Future closing costs: If you don’t retain the line of credit for a specified time, you will incur closing costs from some financial institutions when you did not pay any initially. This will be specified in your loan agreement.
Fortunately, there are excellent sources of information that will provide you with the financial institutions offering the best terms for HELOCs. Go to Bankrate.com for the latest information regarding which financial institutions are offering the best terms for HELOCs.
I have used HELOCs three times, even recently, for personal residences I have owned. I have found these loans to be very flexible with low interest rates.
I have used the loans very sparingly, but they did provide piece of mind in case I did need the funds. They are an excellent option to have.
In my opinion, the advantages of HELOCs vastly outweigh the disadvantages.
Elliot Raphaelson welcomes your questions and comments at raphelliot@gmail.com.
© 2020 Elliot Raphaelson. Distributed by Tribune Content Agency, LLC.
