With home equity values at all-time highs and inflation straining the budgets of everyday Americans, it can be tempting for homeowners to utilize the increase in their home’s value over the past few years in the form of a home equity line of credit (HELOC). While the HELOC can be a great source of financial security, if used inappropriately, it can also be a source of great financial pain.
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Understanding the HELOC
The HELOC is a great tool offering homeowners with substantial equity in their home optionality in their financial life. However, despite the positives of the HELOC, there are key details to understand. First, the interest rates associated with HELOCs are variable and typically based on the prime rate (Fed Funds rate plus 3%). Over the past few years, the prime rate was historically low, making the decision to utilize a HELOC an easier one. Now the decision requires more thought in part due to the onset of inflation, and the Federal Reserve’s response of increasing the Fed Funds rate. In the past six months, HELOC rates increased from approximately 3.25% to approximately 5.5%, and will likely end in 2022 at north of 6%.
Recommendation: Thoroughly analyze why you intend to utilize the HELOC and the cost/benefit before moving forward.
Productive Uses of the HELOC
While there are many potential uses for the HELOC, there are a few that stand out as the most productive. First is using the HELOC for emergency liquidity or as a part of your emergency cash reserve. Many households struggle to create a sufficient emergency cash reserve (3-6 months of your monthly cash flow need is recommended), so using home equity as a part of that reserve can solve a major problem. Second, if you have outstanding high-interest debt, specifically credit card debt, it may make sense to utilize the HELOC and trade the higher interest debt for lower interest debt. Lastly, except for certain circumstances (i.e. payment of high interest debt as mentioned above), look to utilize the HELOC only for short term financing i.e. needing cash to purchase a home for negotiating leverage, or paying off other debts when bonuses, accounts receivable, etc. are assured in the not too distant future. **IMPORTANT** The HELOC should NOT be used for frivolous spending!!
If you are uncertain about whether a HELOC is right for you, please seek the advice and counsel of a Certified Financial Planner™.
Marshall Clay CFP, J.D., is a Partner and Senior Advisor at The Welch Group, LLC, specializing in providing Fee-Only investment management and financial advice to families throughout the United States. Marshall is a graduate of the United States Military Academy in West Point, New York, the Cumberland School of Law in Birmingham, Alabama, and is a CERTIFIED FINANCIAL PLANNER™. In addition, Marshall is a frequent guest on local television stations as an expert on various financial planning matters.
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