- Cash to use for investments or purchases , Convenient way to withdraw large amounts of money
- And at one of the lowest rates available Interest is tax deductible
- Pay off and re-borrow
- A charge on your home which helps prevent mortgage fraud
- You need to be financially prudent and disciplined
House Free and Clear? –Here’s Why You Need a Line of Credit
A home Equity Line of Credit (HELOC) is a useful tool to any homeowner, yet I still meet with clients who are skeptical about using one. This has prompted me to write a concise post listing what I believe to be the advantages of a HELOC and the one reason you might not want one. As always I’m looking to impart some of my financial knowledge I’ve gained advising clients over years and studying finance at one of Canada’s top business schools – The Schulich School of Business.
Reason #1: Liquidity
Having assets that are liquid enables you to take advantage of opportunities. An opportunity may present itself as a chance to buy an investment, a chance to pay off your credit card balance, or to buy a camping trailer at a great price. When you need a large sum of money to get a great deal, or invest to make more money, where will you get it? The short answer is that pulling the money out of your home is a great way to take advantage of opportunity.
Reason #2: Low Cost of Borrowing
As I have mentioned in some of my other posts, borrowing money using real estate as security will help you get one of the lowest rates around. Currently, most financial institutions offer HELOCs at 3.5% (Prime + 0.5%). Most reasonable investments should expect to return much more than 3.5% even in tough economic times like these. As an example, the S&P/TSX composite index closed July 23, 2014 at 15,394.38 which was up from 12,672.30 exactly one year before on July 24, 2014, a gain of 21.4%. More than 20%!!! This is not your typical return, but we had a good year in Canadian markets. How much profit would you have made if you borrowed money on your home to invest in the market? I don’t want to upset my readers, so take a breath before you continue. If you borrowed $100,000 against your home, you’d have earned $21,400 less the interest charges of $3,500 and assumed taxes of$6,265 at 35% for a total gain of $11,635. If you’re one of the lucky few who own a million dollar home free and clear, you’d have earned $69,810 on borrowed funds of $600,000. Why do you think you can or should afford to have your money tied up in your house?
Reason #3: A Charge on Your Home Helps Prevent Title Fraud
Fraud is always prevalent where it can be profitable, and fraudsters are always discovering new ways to rip off everyone from the big banks to Johnny Homeowner. An example of a very profitable form of fraud is Title Fraud. Title fraud usually occurs when an individual steals a person’s identity and takes a mortgage in their name against a home that is rightfully owned by the victim. The fraudster then takes the funds advanced as part of the loan and disappears, leaving the homeowner to pay the bill. Title fraud can be prevented by having a charge on your home which prevents someone else from borrowing against the home. The result – opening a HELOC can be an easy way to add one more layer of fraud protection to your home and life.
Why you might not want a HELOC
After listing numerous advantages, I will also give you the #1 reason not to take out a Home Equity Line of Credit: your own discipline. A HELOC has the potential to be a very large loan and needs to be managed very carefully. Some individuals who have issues budgeting may run up the line of credit too high and have trouble paying it off. Given the fact that they are usually issued with variable interest rates, your payments can increase drastically if the prime rate goes up. The way to mitigate this risk is to be financially responsible, and plan when to use the funds and for what. A line of credit is a great way to shift your high interest credit card debt to a lower rate, but shouldn’t be used as an excuse to run up an unmanageable amount of debt.
If you can operate on a budget, with discipline and understanding of your financial situation, a HELOC is a great tool for building your wealth. Feel free to leave questions in the comments section below.
More finance to come!