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Articles
Think it’s Time to Tap Your HELOC for an Investment? Get
Some Advice First
Any bank or mortgage broker who wants to loan you money for a
home equity line knows it’s in their best interest to lend right
up to your credit limit. They make more money that way. Yet just
because you qualify for a home equity line doesn’t mean you need
to use it, particularly as a bank for investment purposes.
Quite a few things need to go your way for you to use your home
equity line effectively. There’s plenty of risk in plowing loan
money into investments that may suddenly lose their value if they
mirror the Dow’s drop over recent weeks. While home equity loan
interest rates may cost you less than borrowing from your investment
brokerage firm by purchasing investments in a margin account,
you still need to be very careful.
To borrow home equity effectively, you need stable interest rates
and rising home values that go with a strong economy. Remember
that mortgage professionals are not investment professionals or
financial planners - that’s why they’ll always encourage you to
borrow if you have the flexibility to do so. For balanced advice,
you should consult a financial planner professional.
In all honesty, most planners would tell you that if you need
to borrow from home equity, you may not be in the strongest financial
position to make an investment in the first place.
It makes sense to go over a few home equity borrowing basics.
There are two primary kinds of home equity debt. A home equity
loan is a one-time, lump sum that is paid off over a particular
amount of time with a fixed rate and number of payments. A home
equity line of credit (also known as a HELOC), works more like
a credit card because it has a revolving balance - interest is
due on the outstanding balance and that rate may vary over time.
Here are the things you should discuss with a trusted financial
adviser before you tap home equity to put in real estate, securities
or any other form of investment.
- Will your investment deliver a greater after-tax return than
you’ll be paying for the loan on an after-tax basis?
- Does your home equity loan or line carry an adjustable rate?
If so, a jump in interest rates may make what you owe even more
expensive and further offset any gains you make in your investment.
If rates fall, it’s good news, but given current conditions,
it makes sense to be cautious.
- How much is your property appreciating each year in your neighborhood
on average? Is it enough to further offset the cost of your
investment? Keep in mind that no one is predicting the type
of double-digit property appreciation we saw before 2005.
- How will this loan work for you from a tax perspective? Keep
in mind that home equity loans over $100,000 are generally not
tax-deductible.
- What if you need your home equity borrowing power later for
an emergency (the real reason most of us should open a home
equity line and then avoid using it)? Could you handle that
emergency if your borrowing was strained to the maximum?
- How liquid is this investment? If you had a sudden major expense
or lost your job, could you turn it into cash without major
hardship?
- How are your other debts? Do you have significant balances
on credit card or auto debt? That may raise the rate you pay
on your loan - another potential cut in your investment profit
potential. As long as you can deduct the interest, you might
just be better off consolidating and paying off debt rather
than taking a flyer on an investment.
- How close are you to retirement? From a cash flow perspective,
will you be able to handle the loan payments, assuming your
investment using the home-equity funds doesn’t work out?
Home equity is a good option for many important financial goals,
but you have to balance risk against potential reward. In most
cases, it is always good to hold home equity in reserve for a
real rainy day.
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