Just like the real estate market skyrocketed a few years ago, so did the home-equity lines of credit. But when the real estate market crashed, the HELOC followed the wave right back down. Like home sales, once the economy stabilizes, the HELOC will once again be easily available. While you won’t be able to borrow at as low of rates as once before, it will still help out tremedously. Check out some tips for borrowing a home equity line of credit.
Don’t borrow the max
Most lenders won’t approve a line that brings your total housing debt to more than 80% of your home’s value, and you’ll need a minimum 740 credit score to get that much. But there are good reasons to borrow less. You should aim to keep your total monthly debt payments at no more than a third of your take-home pay. Keep in mind that as the economy recovers, HELOC rates will rise too, so borrow only what you could keep up with if rates jump. If you were to take out a $75,000 HELOC today, for example, you’d owe $344 a month in interest; if rates rise a couple of percentage points the monthly tab will jump to $469.
Use it the right way
By now you almost certainly know that using your home-equity line for frivolities like vacation packages and plasma screens is asking for trouble. Other traditional uses may or may not still make sense:
Home improvements. Tapping your HELOC to fund necessary projects like a roof replacement is still worthwhile: You can deduct interest on up to $1 million when you use HELOC funds to improve a first or second home, which in turn sharply lowers the real cost of the loan. Renovations that won’t necessarily pay for themselves, like a media room or a deluxe kitchen? Take a pass.
Car loans. At a 7.3% rate, a three-year new-car loan costs a lot more than a line of credit. A HELOC can be a good substitute — as long as you expect to pay it back within a few years. You may be able to write off the interest. Though the rules are complicated, in general you can deduct interest on a HELOC for up to $100,000 of non-home-related uses.
Student loans. Max out government-backed Stafford and PLUS loans first. The interest on these loans is usually tax deductible, and they often offer flexible repayment plans. But if you have to take a private loan, a HELOC can be a cheaper alternative.
Small business. Entrepreneurs have long used HELOCs as easy business lines of credit to smooth out bumpy income. Steer clear of that unless you’re confident the business is solid, says Newtown, Pa., financial adviser Jonathan Heller.
Make sure you keep it
If you’re going to use a HELOC as an emergency fund, you have to make sure your line isn’t pulled out from under you. Most banks have stopped freezing existing HELOCs, but that could happen if real estate values drop in your neighborhood. Your best defense is to use your line regularly, even if you take out just $500 at a time. Even during the worst of the credit crisis, issuers weren’t freezing or closing HELOCs that were in use as long as the homeowners weren’t underwater.If you think you’ll need to use your HELOC in a few months and are concerned that it could get chopped, borrow the funds now and park them in an FDIC-insured account to keep them safe. Then start paying the loan back ASAP.
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