Homeowners: What Do You Do If You’re Sitting on Equity?
January 19, 2017
There are many wise and unwise uses for home equity. In recent years, it has become more common for homeowners to have a tremendous amount of equity or even have their home paid off. One option available to these homeowners is to take out a HELOC, or a Home Equity Line of Credit. I must advise everyone interested in HELOCs or other means of borrowing against their equity to take caution—you need to fully understand the risks and rewards of each opportunity before making a major decision.
Years ago, HELOCs were the plague to homeowners and lending institutions. Today, I am happy to report that home prices have been rising for 53 straight weeks. In the first three quarters of 2016 alone homeowners added $837 billion dollars in total equity. A HELOC is now a more viable option depending on your financial situation thanks to these market conditions.
There are many homeowners who have misused their home equity, but there are also many HELOC success stories. My purpose today is to coach you to utilize your home equity correctly. Here are a few examples of improperly used home equity:
In 2005, there was an individual working in insurance who developed a scheme that preyed on individual homeowners. He asked each owner to pull their equity amount to invest in a “Universal Life Insurance Policy,” then take a loan against the policy to purchase a piece of investment Real Estate. The convoluted plan had a million red flags, but he advertised nationally nonetheless. He targeted innocent homeowners and many fell victim to his scheme. Some lost their homes. People may start getting these phone calls, mailers and other similar advertisements soon so please be cautious.
Others fell victim to their own risky behaviors and tapped into their home equity for no reason. They made frivolous purchases and ignored the long term consequences for short term happiness. The problem arises when you borrow from your home equity and a major market correction surprises everyone. You are underwater and have no leverage in this scenario—all you can do is ride the storm out.
Lastly, during this time thousands of new, entirely inexperienced realtors were entering the industry through various avenues of employment. People dove in head-first because they were attracted to the quick profit associated with a favorable market. In turn they failed to give trustworthy advice, saying homeowners could purchase homes and flip them immediately for a profit.
Borrowing against your home equity is an incredibly serious topic. Strictly follow this 9 point plan to avoid going down the wrong path. Read responsibly!
What can I use my home equity for? The Pros and Cons:
- Pro: This has always been a significant reason to utilize your home equity. If you bought your home in the last 3-5 years, you took advantage of a great rate. You could take out a HELOC to access your home equity and consolidate various personal debts, especially if other debts have a much higher interest rate than the one on your home.
- Con: you’re increasing the leverage on your home.
- Pro: Many people are taking advantage of high equity to use as a down payment on an investment property. The right property can be an exciting project which provides steady income if rented out.
- Con: Not all investment properties will make you a profit due to the fluctuating vacancy factor. Renters will not always occupy your residence when there are better or more affordable options for them.
- Pro: Real Estate Experts like Dwight Millard of Academy Mortgage find that there are more people today taking out HELOCs to improve their homes. This is especially true for those who make home improvements which help aging family members. Dwight agrees: taking money out of an investment to put directly back in is a smart move if the end result will make you a profit. Think through the right improvements that will generate the best return on your investment. Renovations aren’t cheap, so this is one good avenue of financing your remodel or fixing items that need attention.
- Con: not all improvements apply! Superficial, high-maintenance items like landscaping will not bring you a great return on your investment.
- Pro: With the right business plan, taking out a HELOC grants entrepreneurs the opportunity to take the big leap. You can request a copy of my 25 Point Business Plan for Entrepreneurs and other business planning articles by calling (775) 800-1801. However, I would advise every entrepreneur to consider borrowing against their equity with a grain of salt. Understand this is a huge risk that has benefits on a case-by-case basis.
- Con: you risk your house and your livelihood for the sake of business.
- Get Rid of Your Private Mortgage Insurance
- Pro: Let’s say you bought your home 98% Loan-To-Value and scraped in with the lowest down payment possible but you now have equity. In this scenario it is a great idea to refinance with your HELOC despite higher interest rates. This would allow you to stop paying that 2% for PMI. If you only have 10% to put down towards a down payment but you take 10% from your HELOC, you actually are in an 80% loan with no Mortgage Insurance (80-10-10 loan structure.) It’s also a way to exit out of a jumbo loan. If you use the Home Equity Line of Credit you can get down to conforming loan rates.
- Con: We are in an environment of rising interest rates. This change may be time sensitive or non-beneficial if rates continue to increase. Talk with your lender to learn more.
- Loan Money to a Family Member
- Pro: There are many delicate family life situations which call for helping one another through a rough time. Loaning money is always your choice as a family member, not a requirement. Always be careful in these situations—in the worst case scenario this can cause a riff in the family dynamic.
- Con: If you have a family member who simply needs money for a luxury (such as starting a band), putting your financial situation in jeopardy is a high risk low reward action.
- Pro: If you find yourself quickly outgrowing your property, it may be a good time to move up and out of that starter home. A word to the wise: timing is critical. You will want to take a HELOC on your primary residence, wait to find the perfect home at the right rate. This is assuming you will keep the starter home and utilize it as a rental property to ensure you have income from your first home.
- Con: market conditions may require you to wait longer than you want to.
- For Medical Services or Assisted Living Care
- Pro: If you or a loved one are aging to the point where assisted living becomes necessary, a HELOC is a great way to finance it. Assisted living can cost upwards of $5,000/month. If you are like many Americans who do not have this cash on hand, fret no more.
- Con: Medical bills are outrageously expensive no matter how you finance them. You and your family should consider whether or not there are better personal or financial alternatives for your loved ones.
- Get rid of a balloon payment
- Pro: Borrowing against your home equity can help you totally eliminate a 10 year and 15 year balloon payment. This is a repayment of the outstanding principal sum made at the end of a loan period, interest only having been paid prior. Borrowing in this manner may also be beneficial for getting rid of IRA payments, etc.
- Con: You’ve traded one balance of debt for another.
Here’s the bottom line: be prudent. Understand you are going into debt every time you write a check against your line of credit. Speak with your accountant in case the interest is tax deductible. Use good judgment.
(Sources: Realtor.com, Realtytimes.com)