If you are a homeowner, your primary house is often your most valuable asset. However, unlike other assets, you can’t just sell your house and collect your profits; you need a house in which to live. So, if you do not plan on selling your current home and buying another, this valuable asset does not offer you much in the way of utilizing its accrued value. There are a few options, including reverse mortgages and cash-out refinances. Reverse mortgages generally present more problems than solutions, and in our current rising rate environment, refinancing is very unappealing. There is a third option, however, and it is frequently used by homeowners looking to tap into their home’s equity: a home equity line of credit, or HELOC. How does it work? And what should you look for before opening one?
HELOCs let you borrow money against a portion of your home’s equity — the difference between your mortgage balance and the house’s appraised value — up to a certain amount. You can borrow from the HELOC over time as you need the money instead of getting it all at once as you would with a loan. They can also have lower interest rates and fewer upfront costs than some options. Think of the interest you are charged as a fee for allowing you to cash in on some of your home's equity. In this respect, HELOCs aren’t “borrowing” in a traditional sense, as you are borrowing from yourself.
Too good to be true? HELOCs can be good, but look for these three things:
- Variable interest rates make it tough to budget
The interest rate on HELOCs is typically variable, meaning it moves up and down based on the so-called prime rate, which banks use as a basis to set rates on a variety of loans. While the Federal Reserve doesn’t control the prime rate, it is influenced by the Fed's changes to the Fed Funds Rate.
- It may be difficult to pay off the principal
HELOCs typically only come with monthly interest payments — meaning none of your minimum payment goes toward the principal.
- Use it for the right reasons
Sometimes, homeowners turn to a HELOC to pay off higher-interest debt, such as credit card balances. Other times, since they are technically borrowing from an asset they own, people become careless with a HELOC and get into trouble. HELOC’s should be used for short-term, temporary funding needs that you’re going to pay off within a finite period of time. If you have longer term reasons to access the equity in your home, you should explore options that provide more certainty around interest rates and principal repayment.
Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice. Any views expressed herein are those of the author(s) and not necessarily those of Multnomah Group or Multnomah Group’s clients.