1. A home equity loan is a loan that is taken out against what the home is worth – the loan you currently have on the house. For example: the house is worth $175,000 and you owe $125,000 on your current first mortgage. You could take out a home equity loan for $175,000 – $125,000 = $50,000.
2. During the height of the refinance boom some mortgage companies were letting home owners take loans up to 125% of the value of their home. Everybody thought that this was going to be okay because real estate always goes up and more than likely the home would be worth more than what you would owe on them in the next year or so. It was easy for banks to think that way because almost every home in America doubled in so called value over a 3 year span. So in the example above you could take out a loan for $175,000 x 125% = $218,750 – $125,000(Current Mortgage Balance)=$93,750. That’s $43,750 more than what you could if you could just go up to 100% of the value. The banks thought this was a good idea because now they could collect more interest on more lent money. Dumb.
3. Not to get off track but many people took out 80/20 loans to get away from private mortgage insurance(PMI- Which is dumb as hell). So you take out a conventional 30 year fixed rate mortgage up to 80% of the value of the home and a Home Equity Loan to cover the other 20%.
4. The Home Equity Loan gives home owners a lot of flexibility in what they want to do with their payments. From this point on I’m going to assume that you have equity in your home and are not purchasing a home so you see the benefits of having a HELOC. The only thing with a HELOC is that it as an adjustable rate loan. Every time you hear on the news that The Federal Reserve raised or lower rates HELOC’s are affected. Your payment will move up or down every month that The Fed does this. Some banks offer fixed HELOC’s but they are few and far between. The adjustable interest on the home equity loan is the trade off for the flexibility of the loan. It’s not a bad thing if you use the HELOC correctly.
5. The payments on a home equity loan are based on a 30 year amortization schedule with the first ten years being a interest only period. The cool thing is that you only pay interest on what you borrow. As an example lets say that you want to put some new cabinets in your kitchen but you do not have all the money that its going to take to pay for it. You go to your bank and open up a HELOC and lets say they give you this line of credit up to 100% of the value of the home. I like the example above where you have $50k of equity. You need $8k to finish the kitchen and that’s it. Let’s say that your interest rate is 5% (it will probably be higher but use this as an example). Your payment the next month is $8,000 x 5% = $33. That is a pretty cheap payment for $8k. The $33 is just interest so if you only make a payment of $33 then your balance will be the same until year 10. At year 10 the HELOC changes into a 20 year loan where you have to pay down the balance.
6. So now you have a balance of $8k so what does it mean to have a $50k HELOC. Think of it as a credit card limit. You can borrow up to $50k at any time. Some banks even give you checks to write them from your account. Others will make you call them and they will overnight a check. So in our example you have $42k to use at any time. I am by NO MEANS saying that you should go write a check for a Cadillac Escalade or something you do not need (this is what a lot of home owners did during the mortgage mess) but its nice to know if you have an emergency and need quick cash.
7. The cabinets are installed and the kitchen is complete. You were able to get the $8k you needed in the first place to pay for it. What do you do now? Do you keep the money and put it in the bank(OK Idea)? Do you go out and blow the $8k on a vacation(Bad Idea)? Or do you pay back the $8k towards the HELOC? PAY IT BACK. No need to pay interest on something that you earmarked in the first place. Remember, if things get tight you can always take that money back out at anytime. Debt = Bad.
8. The HELOC should be used for the right things such as an emergency, home improvements, college tuition’s and oh what the heck you can even say weddings. We all now how long weddings take to plan so if you don’t have the money right there but will get it by the end of the ceremony you might as well use it. Instead of making your kids get student loans take money out of your HELOC and pay their tuition with it. Since a home equity line of credit is a loan against your house you get to write off the interest that you pay. You don’t get to write it all off but every bit helps.
9. If you are an investor and like to buy stocks or flip homes than you need a HELOC. This should almost be considered cash. You can tap it at any time and if a great deal comes around you do not want it to pass you buy. Get out the checks for your HELOC and write a check that day.
10. One of the coolest features of a home equity line of credit is a little trick you can do to help pay down your bills or the balance on your mortgage. There are a couple companies that do this and they call it Money Merge Accounts. Its their way of selling you into a program to do what I can show you for free. I’m going to write another post about it in the future that’s more in depth but here’s the basics. On the HELOC you pay little interest on big amounts. Example: $125k 30 Year Fixed Mortgage at 6% has $750 monthly payments were $625 of that is interest. So only $125 goes to pay down the loan. Over one year your balance will go down $125 x 12 months = $1500. So lets say one month you write a check from your HELOC for $2k towards one months payment on your first mortgage. Your payment is $750 so $1250 went on top of the loan to pay down the first mortgage balance. That $2k is now a balance on your HELOC where your payment (I’ll use 7%) is $2000 x 7% = $140 interest in one year / 12 months = $12. So what you effectively did now was transfer a lot of interest from your first mortgage to your second mortgage. You basically are going to double the amount of principle you pay off on the mortgage every year. Which in the long run will save you in the tens of thousands of dollars. When you get your HELOC bill the next month all you have to pay is the $12 but you should pay $750. This might be confusing and I’ll work on a post in the future so its more detailed. All in all the HELOC gives you a ton of flexibility with your finances and can be considered your emergency fund in tough times.