Understanding HELOCs & Home Equity Loans

Amid today's economic landscape and soaring housing costs, many homeowners are turning to the equity accumulated in their home as a valuable and readily available resource. Often, this financial strategy involves tapping into the home’s equity through options such as Home Equity Loans (HELs) and Home Equity Lines of Credit (HELOCs). For cash needs, some homeowners may consider accessing savings, investment portfolios or even 401ks as a resource of available funds. Each of these options offer you distinct advantages and disadvantages, depending on your individual financial objectives and circumstances. In this article, we discuss the choices, delving into nuances of HELOCs, Home Equity Loans, and the potential effects of each on your overall financial situation.

Let’s Talk Cash

Some homeowners may have extra cash or liquid investments, alleviating the need to for a loan. For a variety of reasons, tapping into your cash reserves or investment holdings to cover the costs of home renovations or a major expense is not always the most prudent financial decision. First and foremost, depleting cash reserves or liquid investments may erode your hard-earned financial position, create an additional tax burden, and limit your flexibility to manage unexpected expenses or emergencies. Additionally, sales of investments to raise cash, such as stocks or mutual funds, may trigger capital gains taxes or penalties, impacting your entire investment portfolio and tax landscape.

Investments typically generate returns over time, and prematurely liquidating these may hinder long-term growth potential. Additionally, financing home renovations or other expenses using cash or investments might undermine opportunities for leveraging debt options, like HELs or HELOCs. These home equity loans potentially offer more favorable terms and preserve liquidity for other financial ambitions. Therefore, careful consideration and consultation with a trusted financial advisor is fundamental to weighing your immediate expense needs with your long-term financial health and goals.

Home Equity Loans

Home Equity Loans (HELs) enable a homeowner to borrow a lump sum of money based on the equity accrued in their property. According to the Wall Street Journal, HELs “typically allow borrowers to access up to 80% to 90% of their home's appraised value, minus any existing mortgage balance.” The amount borrowed is available to use for various purposes, including home renovations, debt consolidation and other major expenses. HEL repayment is similar to a traditional mortgage, with borrowers making regular monthly payments, inclusive of both principal and interest, over a predetermined period, usually ranging from 10 to 30 years. The structure of a home equity loan is akin to a second mortgage, and the financial commitment mirrors that of the original home loan, providing stability and predictability to help with budgeting. Other important considerations are the evaluation of the interest rate, the total interest amount, and the potential value of the property at resale. Knowing these three factors helps you weigh the option of a HEL and choose with confidence based on your individual financial picture.

HELOCs

A Home Equity Line of Credit (HELOC) offers a more flexible borrowing option. Rather than receiving a lump sum amount upfront, HELOCs function similar to a credit card, providing homeowners an available revolving line of credit to use as needed during a specified draw period, typically 10 years.

The initial phase often requires borrowers to make interest-only payments on the amount withdrawn. After the draw period ends, repayment terms vary. Some HELOCs offer a repayment phase requiring borrowers to make monthly payments of the principal and interest, while others may require a balloon payment of the remaining balance. Such flexibility makes a HELOC ideal for homeowners who anticipate the need for funds intermittently or who prefer to have financial resources available for future expenses. Interest rates for HELOCs are usually based on the Prime Interest rate plus an additional percentage, highlighting the importance of evaluating the term, the interest rate, the cost of funds and available options for refinancing. Payment of a monthly HELOC may be a challenge in an environment with rising interest rates. In contrast, the option of refinancing, especially at a lower interest rate, can provide a fixed payment, potentially saving money overall.

Summary

The WSJ along with Jeff Levinsohn, CEO of House Numbers, notes the practical benefits of utilizing home equity products for qualified borrowers. He notes that these financial tools are particularly advantageous for individuals with stable, predictable incomes and credit scores above 640. "If you're using home equity to pay off higher-interest debt," Levinsohn explains, "you can eliminate those monthly payments and potentially free up additional cash flow each month." Strategically and prudently using the equity in your home may help reduce your overall debt burden, and potentially help to provide both financial flexibility and long-term financial stability.

At ClearPlan Wealth Management, many of our clients rely on our experience and depth of industry knowledge to navigate complex financial decisions. When considering HELs and HELOCs, we help connect you with the trusted professionals and valuable resources to navigate the nuances of the home loan process. Give us a call ! We’d be happy to connect you with our team of trusted professional resources happy to support you along the way.

About the Author:

Troy Brewer has a talent for connecting successful people while serving as a respected mentor on the path to prosperity. By facilitating an all-encompassing approach to wealth management, Troy utilizes his extensive network of resources including investment bankers, estate planners, accountants, and business leaders to develop creative financial solutions for his clients. By fostering meaningful relationships, orchestrating financial strategies, and serving as a trusted confidant, Troy helps his clients achieve their desired life and legacy.

Troy has spent more than 25 years in the financial services industry, focusing on maintaining tight multigenerational relationships through a process-driven approach. As a Chartered Retirement Plans Specialist^® and member of the Baltimore Estate Planning Council, Troy specializes in low-cost investments, complex / multigenerational wealth planning and tax efficiency. His clients include business owners, corporate executives, and affluent families. Learn more about Troy or schedule a consultation.

Any opinions are those of ClearPlan Wealth Management and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. This information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While we are familiar with the tax provisions of the issues presented here, as financial advisors of Raymond James, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional. Every investor’s situation is unique, and you should consider your investment goals, risk tolerance and time horizon before making any investment. Prior to making an investment decision, please consult your financial advisor about your individual situation. Raymond James does not provide tax or accounting services.