When we started working with a financial advisor a few years ago, there were very few things that surprised me.
Since we’d already created a financial plan without an advisor, I had my savings goals all set up, my plan of attack, and everything was feasible given our financial situation.
Where we had holes were in our system overall because I didn’t have a full picture of what we needed and, honestly, had no one pushing me to do them. The best example was our estate plan – we didn’t have one! In the years since our first few meetings, it’s something we’ve checked off our list and taken care of.
Another example of this was opening a home equity line of credit for financial flexibility. I had no reason to get one – I wasn’t consolidating debt, I wasn’t planning a major home improvement, and so without those very common use cases, I never thought about it.
So when our advisor suggested it – I wondered why? It’s so you have access to the credit even if there’s no immediate need. If one appears, it’s there and you don’t have to go through the process.
The interest rates and calculations in this post date back to November 2016. Capital One no longer has a home loans line of business.
Table of Contents
What is a Home Equity Line of Credit?
A home equity line of credit (HELOC) is a line of credit where the collateral is the equity in your house. It’s not a loan and you don’t get a lump sum. You simply have access to this line of credit.
A few terms to know when it comes to HELOCs:
- Draw period: How long the line of credit is available – so if you have a 10 year draw period you can draw on the LOC over 10 years. During the draw period, you only pay interest on what you borrow – you don’t have to pay down the principal. If you do, you get access to that credit again.
- Repayment period: The period after the draw period, where you can’t borrow anymore and now the HELOC is like a regular loan. The interest rate is fixed now.
Our advisor recommended it because it gives you additional financial flexibility if you ever need a large sum of money. Many people use it to consolidate debt since the HELOC interest rates are going to be lower than most other interest rates, or use it to make home improvements, pay medical bills, or for education.
What separates a HELOC from a loan is that you only pay interest on the sum you borrow. If you have a $10,000 HELOC but borrow none of it, you pay no interest.
A HELOC isn’t free though – it’s like getting access to a loan without many of the fees. A lot of banks do not charge a closing cost fee. That’s huge.
There is an annual fee unless prohibited by state law, and an early termination fee if you close it within a certain number of months (like 36 months), again unless prohibited by law. All banks will charge this fee and it varies but usually around $50-$75 for the annual fee and $400-500 for the early termination fee.
Let’s See Some Numbers
I went to Capital One’s Home Equity calculator (no longer available), one of the brand’s tools that help you choose the right option for your situation, to get a quick estimate of how much it would cost to open one up (all numbers are accurate as of November 2nd, 2016).
In Maryland, if you have a $300,000 home with a mortgage balance of $150,000 (so equity of $150,000), you can get a HELOC with a limit of up to $90,000 with an interest rate as low as 3.20% variable APR. Learn more here.
That’s what this easy to use, simple tool tells me. I can find this all without putting any personal information, which is convenient.
To get a more accurate interest rate, I will need to enter more information so they can check (though thanks to how Capital One does the inquiry, it will not affect my credit score).
If you click on Get Started on www.capitalone.com/home-equity, you can get an even more personalized quote and rate. That’s when you’ll enter your personal information, including social security number, and Capital One will begin the process of checking your credit (again, it’s a soft pull so it won’t affect your credit score). There’s no application fee and if you open a HELOC, no closing costs, so the only cost is the $50 annual fee. For more, click here.
(On an unrelated note, having never done this before I thought this type of thing would be complicated — it seems remarkably easy. I love the internet!).
I don’t plan on using it unless I need it, so I see no obvious downsides. For $50 a year, I have access to a $50,000 line of credit with a reasonably low-interest rate (that I don’t pay unless I borrow money).
It seems like a useful financial tool. What do you think? Am I crazy?
Carla says
Went to Capital One site and even with excellent credit it came back at over 6% rate. That is like bait and switch to me. Advertises 3.20 and then comes back that high. Crazy. I am in Maryland as well. Are all banks/lenders going to be like that?
Excellent question – we all know that every time a rate is advertised it’ll be the rock bottom rate. So all banks will say their lowest possible number and who knows who qualifies that that.
When I played with it I was told it’d be somewhere in the 4.5% range for both a 30 and 20 year line of credit and I have excellent credit too. Perhaps it was loan amount? Some other LOC related factor?
MICHAEL HAWKESWORTH says
Jim,
I appreciate your efforts to educate our populace in financial wisdom and responsibility. It has not gone unnoticed by me since signing up for your information.
That said my recent reading (last 6-8 months) about HELOCS and their affect on banks and borrowers indicates more problems than advantages for both bank and borrower. The banks can’t sell the loans and the borrowers didn’t budget for the increase in their household payments. Of course the responsibility in creating personal debt is on the borrower.
These HELOCS could prove to be a disadvantage if these home values which have risen back to just below peak values in most cities crater again as in 2009.
Again personal responsibility it key!
Regards,
Michael
*disclaimer: built a net worth of 12 million dollars between 1998-2015 on 2500.00 cash and real estate debt. Have been debt free since 2007.
Hi Michael – I’m not concerned about the affect on the banks, that’s for their underwriters to worry about. As for borrowers, those concerns would exist for any type of loan. If you don’t budget for the increase in household payments because you utilized the cred line, you’re a fool. It’s not limited to HELOCs.
As for a disadvantage if home values fall, how does it impact the borrower if the value falls? The line still exists and the flexibility is there. Falling home values would be a negative if you are going to sell, or if you were trying to get another or increase a line, but otherwise it’s unimportant.
MICHAEL HAWKESWORTH says
While I agree with all you said I will just add this:
1. The banks got bailed out with OUR money.
2. Most of our populace are fools in my opinion.
Appreciate your efforts to educate.
Regards,
Michael
1. Yes, but those programs ended up being profitable (though not the intent going into them). And the banks didn’t have issues because of HELOCs, it was all CDOs and derivative products that were marketed as safe but ultimately filled with hot trash.
2. Again, nothing to do with HELOCs. 🙂
Jane says
Capital One makes these loans in only nine states. And my state isn’t one of them!
Good idea though if used properly.
Excellent point!
Jim Astor says
I have two HELOCs from Pentagon Federal Credit Union and am quite pleased with the rate and terms. There are no fees. We used the first line to do some home improvements, and then kept the line open for any emergencies or special needs. The second line was to help my son fund his business start-up as the banks refused to take the huge “risk”. My son is paying off the credit line at an accelerated pace and I’m confident he will be able to obtain future financing from Pentagon FCU. Banks have proven themselves to be only interested in lending to well established companies with little or no risk, while charging their other clientele outrageous fees for poor services and products. Credit Unions are the way to go.
Jen says
I recently read some asset protection books and learned HELOC is also a good tool for asset protection purpose. I forgot which book mentioned it but did a search and found this similar article online: http://www.investopedia.com/articles/mortgages-real-estate/09/equity-stripping-assets.asp?lgl=b
I’d love to see your view on asset protection.
That’s a fascinating idea I’d never considered, by having a HELOC you add another player in any legal proceedings. I’d never considered it before but I like the idea (if it works).
Lazy Man and Money says
I had a HELOC back in 2006, but around 2008-2009, it went away for reasons we’ll never know ;-).
About 18 months ago, we got another one. The main purpose was to finance solar panels, one of those rare home improvement projects that seem to greatly pay off in the long term… at least in some states.
It had no annual fee and at a 2.99% rate. As we started to pay it off, I realized that it can function as part of an emergency fund. It certainly isn’t a replacement for having access to cash. However, rather than keeping $50,000 in cash, maybe people would be comfortable with $25,000 in cash and $25,000 of a HELOC to tap into. This frees up another $25,000 for investing at higher rates. Since you only pay the small interest rate if you need it, most of the time it just sits there as an insurance policy.
Yeah, so my next post on HELOCs will actually cover emergency funds, so you’re ahead of the game. 🙂
My thinking is that rather than 50k cash you can do 25k cash and 25k HELOC, but that HELOC is backed up with 25k invested. You probably won’t need 50k all at once and so you give yourself time to get the invested $25k out (in an orderly fashion) if necessary using the HELOC as a buffer.
Lazy Man and Money says
Indeed. If you don’t need that invested 25K for 7-10 years and it doubles, you have the 25K in cash, a 50K investment to tap into, and the HELOC you had before. I’d call that a fundamentally stronger emergency fund.
Then you start to layer in the ability to withdraw Roth IRA contributions penalty-free. Obviously it isn’t ideal, but no emergencies are.
I bet there are a number of people with “hidden” emergency funds with potentially $100K that could be tapped who don’t realize it.
Ha for sure, and the only cost is the $50 or so a year you pay on the HELOC.
A lot of times when I look at our net worth, I also calculate a “liquid net worth” that I view as the “what if I had to liquidate everything right now” — that’s ultimately the “shit hit the fan” emergency fund.
Shaun says
I’ve had a HELOC on my property for over a decade now. It can make a good emergency fund and rates are almost always lower than credit card rates. As with any debt, it’s important not to borrow more than you can handle. I have also used funds from my HELOC for a type of arbitrage – borrow against the HELOC at 4.5%, invest at 8%. Free money! (Assuming you can find a safe investment returning 8%, which I did.) But I am really puzzled by the yearly fee on your HELOC. I’ve never had one that charged a yearly fee. Granted, all mya HELOCs have been from brick and mortar banks, so I wonder if your yearly fee is basically a yearly payment for the convenience of opening a HELOC online.
Wallace Wong says
Great articles and comments! These hacks are awesome! I’ve used the HELOC strategy for years now and it’s been working for me. I’ve learned other bank related hacks that I can share… did you know that there are other lines of credit (LOC) out there not tied to your home? A home is just the collateral the bank requires when lending money. I’ve gotten LOCs on cash value in my life insurance policy, stocks, and even CDs. The smaller regional and local banks can do this. You just have to ask. Why do this? Your money is working more efficiently.