Home Equity Line of Credit (HELOC) January 30, 2008Posted by shaferfinancial in Uncategorized.
Tags: Finance, Financial Planning, HELOC, home equity line of credit, mortgage planning, mortgages, real estate, Wealth
Are you throwing away dollars every month using a home equity line of credit?
Many homeowners have added lines of credit they have gotten from banks. Recently I had a very interesting discussion with someone who had a home equity line of credit (HELOC). This person was telling me how happy he was with the line of credit, mainly because it “cost him nothing” and it was prime -1/2%. I found that interesting. His line of credit was costing him 6% currently (If the fed’s lower the rate today it will go down accordingly). He took it out several years ago. It is a variable rate so it goes up and down with the fed’s fund rate. But here is the kicker, on average there is a 1-2% spread between the rate you can get on a HELOC and current 30 year fixed mortgage rates. Remember HELOC’s are second mortgages so they are always going to carry more risk to the lender and therefore have a higher interest rate. His average draw over the time he has had the HELOC is $100,000. So every year he has this line it has cost him $1,000 to $2,000 in excess interest. When I ran the numbers for him, he had already passed the break even point. Had he paid the expenses of refinancing instead of getting that “free” HELOC he would have saved money at this point and every month hereafter will cost him more money. After this discussion he wasn’t quite so happy with his “no cost” HELOC. Many folks are like him and are throwing out dollars every month. Now here is a fact, 90% of those with HELOC’s carry a balance on it the majority of the year.
Here is some advice on HELOC’s:
1. Add a “no fee” HELOC for emergency purposes only. If you are the type of person that can’t keep themselves from drawing from the line for spending then don’t do this;
2. Use a line for temporary purposes only, for example, to build a addition to your home. Refinance if you can’t pay down the line;
3. If you have a HELOC, analyze how you have used it. If you look back and the majority of the time you have a balance on it, then it is time you looked into refinancing the line into a 1st mortgage (assuming you have enough home equity to accomplish this). A competent mortgage planner should be able to run the numbers for you and give you a break even point for the expenses.
HELOC’s are just another example of where the “no fees” option ends up costing you much more money in the long run.