Considering Your Home’s Equity
By Ann Blakey, CFP® at Washington Wealth Advisors
Over the last decade, the Unites States has experienced a dramatic increase in prices for residential real estate. The good news is that this has also translated into an increase in home equity for many home owners. And a home equity line of credit can provide a convenient source of cash for such things as home improvements, business ventures, funding a child’s college education, or purchasing interest-sensitive assets such as a new car or boat.
Simply put, a home equity line of credit is credit secured by the equity in a home. It allows borrowers to raise cash, in many cases, free of taxes. It also typically carries a variable interest rate that is generally more favorable than the rates under most personal loans. In addition, it may offer the added advantage of tax-deductible interest.
HELOC: Advantages & Considerations
Advantages on a HELOC
- Homeowners are generally free to use the home equity line of credit for whatever purposes they wish.
- Interest rates can be lower than that from credit cards or personal loans.
- Interest is generally not charged until the home equity line of credit is used, although some lenders may charge an “inactivity fee” if the credit line is not used within a specific period of time.
- HELOC interest can be tax deductible if the borrowed funds are used to buy, build, or substantially improve the taxpayer's home that secures the loan,
- Obtaining a home equity line of credit, even when it may not be needed, can provide a ready source of cash in the future that can serve as a safety net in the event a homeowner’s financial situation changes enough to otherwise jeopardize credit approval.
Considerations to Take into Account with HELOC
- A home equity line of credit can be relatively easy to obtain, yet borrowers must take care to use the funds prudently. For instance, it is unwise to trade off the equity in a house—which is a tangible, long-term asset—for the sake of items that are easily consumed, such as vacations, clothing, jewelry, or dining out.
- Caps on variable interest rates may be as high as 18%. If funds are borrowed for a long period of time, inflation could dramatically affect the overall cost of such credit.
- Tax deductions of eligible interest are subject to IRS limitations.
- Joint homeowners must both consent to a home equity line of credit. However, with most lines of credit, either joint owner may draw checks on the credit line. This makes life easier if, for instance, one joint owner becomes disabled. However, particularly in cases of marital discord, it could leave one spouse open to misuse of funds by the other.
Home Equity Loan: Another Option for Using Your Home’s Equity
Although a HELOC has become a popular financing tool, a Home Equity Loan may be more useful for some homeowners.
- While HELOC is a revolving line of credit, a Home Equity Loan will deliver the homeowner a lump sum up-front which would be more helpful for a large home renovation, for example.
- The costs of the loan are often more predictable since they are usually offered at a fixed rate. This allows borrowers to lock in a favorable rate if they expect interest rates to rise over the course of the loan.
- Also, since payments are generally spread over the life of the mortgage, there is less chance of needing to cover a large balloon payment at the end of the loan.
- For compulsive spenders, a second mortgage may be safer than a home equity line of credit, because it limits the homeowner from drawing down additional funds during the term of the loan.
- As with a HELOC, the interest on a Home Equity Loan can be tax deductible if used to “substantially improve” the home. Joint tax filers can deduct interest on up to $750,000 worth of total qualified loans (including the primary mortgage), while single tax filers can deduct interest on up to $375,000.
It may be inadvisable to borrow against your house in the following situations:
- You are unsure of your job security and repaying the loan would be difficult if your income were to drop.
- You are financing a consumable purchase, such as a vacation.
- Home sales have slowed in your neighborhood.
Explore the Potential Tax Advantages and Favorable Interest Rates
Under the right circumstances, home equity is a valuable resource that homeowners can draw upon to help meet their financing needs. A HELOC or a Home Equity Loan may provide tax advantages and favorable interest rates for those with large, current cash requirements or who wish to create a hedge against future needs. If you are a homeowner, it can make sense to consider unlocking the potential value in your home.
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