One’s home is possibly the most important investment of their life as it houses and protects one’s family and offers the possibility of capital appreciation over time – often creating a retirement nest egg where there once was none.
The reality is appreciation is a significant financial concept because it helps individuals determine if it is a better financial decision to buy rather than rent.
For those who are new to the concept of appreciation, it is important to explain just how important it is about future value. Let’s compare the same property – over time – with similar (but not the same) rates of appreciation. What happens to the potential value of a home given a one percentage point difference in the appreciation rate – over thirty years, which is the typical mortgage term?
The table below delineates how appreciation impacts value over time:
|Appreciation Rate||Future Value|
in 30 Years
The table denotes that the original property would be worth $570,000 in thirty years, given a 3% appreciation rate. However, with just a one percentage point increase (to 4%), the property’s future value would increase more than 33% or $192,000! One percentage point really makes quite a difference over time.
First, though, let’s review a few key terms that will help simplify the narrative explanation that follows:
- Appreciation – generally speaking, appreciation refers to the increase in the value of any asset. The opposite of appreciation is depreciation.
- Home Equity – is a simple calculation of the difference between a home’s value and the total value of any liens that may be attached to the property.
- Home Equity Line of Credit (HELOC) – is a type of mortgage that offers homeowners a maximum line of credit over a preset period. Home equity lines of credit are generally offered in two parts – an access period (which usually is ten years) during which a borrower repays only a minimum amount, during which the funds are reusable. The second portion of the HELOC is typically called the ‘pay-back’ period, during which the borrower pays back the outstanding balance over time but can no longer access the HELOC’s open line of credit.
- 1 The Home Equity Line of Credit (HELOC) – A Great, Flexible Financial Tool
- 2 Once secured, a HELOC works similarly to most credit cards. Borrowers can use all or just a portion of the credit line – when they are ready. Let’s review the seven ways homeowners can use a home equity line of credit to help fund essential life events.
The Home Equity Line of Credit (HELOC) – A Great, Flexible Financial Tool
The equity that collects in one’s home is available to homeowners through a Home Equity Line of Credit or other mortgage instruments. A homeowner can tap into the equity for various reasons; however, it is noted that most lenders will require that borrowers have a minimum of 15% to 20% of the equity in their home. Here is a quick review of the simple calculation used to calculate one’s available home equity:
Home Value – the total of all mortgage liens on the property = Available Home Equity.
$250,000 – $200,000 = $50,000 available home equity
HELOCs offer great benefits to borrowers because:
- The interest rates for HELOCs are typically much lower than credit cards or other non-collateralized loans.
- The interest paid is typically tax-deductible, although it is important to confirm the deductibility of your mortgage interest payments with your financial or tax advisor.
However, it is also essential to note that if you default on your mortgage loan, the lender always has the option of foreclosing on the property to collect their defaulted debt. When borrowing against one’s home, borrowers must understand the potential benefits and the potential risks of the loan.
Once secured, a HELOC works similarly to most credit cards. Borrowers can use all or just a portion of the credit line – when they are ready. Let’s review the seven ways homeowners can use a home equity line of credit to help fund essential life events.
Seven Ways You Can Use a Home Equity Line of Credit
- Put it back into your real estate by upgrading or improving your home.
Updating and improving one’s home can be done in many ways. Renovations are a great way to keep pace with a family’s evolving needs. Also, if renovating, it is a great idea to add energy-efficient upgrades, which can ultimately reduce one’s utility bills each month. Some energy-efficient items even offer tax rebates to homeowners for choosing to install the items. [Check with your tax advisor or consult the IRS’s website for more details.]
Examples of home improvements that help build equity include:
- Kitchen updates.
- Energy efficient windows/sliders.
- Add a second floor and increase the square footage of the home, to name just a few.
Pro Tip – Not all home improvements will result in a dollar-for-dollar increase in the home’s value. Before deciding on the improvement, consider the cost of the improvement, the interest required to hold the debt, and the ultimate impact on the home’s value when complete.
- Utilize the lower interest rates available for HELOCs.
HELOCs tend to offer highly competitive rates, which fall well below the rates charges on automobile loans, credit cards, or student loans, among others. As noted previously, the interest paid on an outstanding mortgage lien/HELOC may be tax-deductible if the money that has been borrowed was used to buy, build or improve the property on which the loan is collateralized. Again, it is prudent to contact one’s tax or financial advisor regarding the most current IRS tax-deductibility laws.
Also, most lenders provide introductory discounts on the rate for new HELOC borrowers, which allows for even greater savings.
Pro Tip – Most HELOCs are offered at a variable rate – which is calculated as Prime Rate + a few points. And while variable rate loans tend to begin at lower rates, rate changes in the economic environment might raise the interest rate over time. Some lenders may offer a fixed rate HELOC product; however, fixed rates are generally higher than their variable counterparts.
- Consolidate outstanding debt to lower monthly payments.
Because the interest rates on a Home Equity Line of Credit (HELOC) will likely be less than most other loans and credit lines, consolidating outstanding loans and credit cards will likely either –
- Lower one’s monthly payment, reducing one’s overall obligations each month.
- Allow a borrower to pay off the same debt – only quicker.
- Reduce the amount of interest paid on the debt if a borrower pays the same amount toward the new HELOC as was paid with the now consolidated higher-interest rate debt.
Note: however, that the relative benefits of choosing to use a HELOC to consolidate debt will be contingent on each individual’s financial, personal scenario.
Pro Tip – Choosing to consolidate credit card debt with a HELOC converts the unsecured debt to that of secured debt. As a result, borrowers should be more than confident that they can afford to meet the monthly debt payments because the lender can foreclose upon the home for nonpayment. Finally, when opening a HELOC, be careful that you do not incur new debt over and above the recently paid-in-full credit cards.
- Help with education costs.
Many people find it hugely challenging to save for education expenses for themselves or their children. HELOCs are a great financial method that can be used to pay for tuition costs if you or your children are considering enrolling in college. A home equity line can be used to pay for upfront tuition costs.
Pro Tip: It’s important to compare the interest rates for Home Equity Lines of Credit against the education debt to be consolidated. And while it is a general rule that the lower the interest rate, the better the financial deal, it is always a good idea to speak with a financial advisor to discover which of the many financial avenues may be best for your specific situation.
- Reconsider large-ticket purchases.
Homeowners should always carefully consider the available financial options when deciding to move forward with large, discretionary purchases. Expensive purchases – like an extravagant wedding or a global vacation would not generally be considered a smart reason to tap the equity of one’s home. This is because HELOCs require a property’s collateralization, which can be foreclosed should a borrower default on their mortgage/HELOC obligations.
It is for this reason that homeowners who are considering borrowing against their home should carefully weigh the benefits and risks of the financial products that are available. It is helpful to speak with a mortgage professional to learn as much as possible to allow you to make the best-educated decision as you reach your financial objectives.
- Prepare for retirement.
For those who are living in (or preparing for retirement), a Home Equity Line of Credit is often a valuable financial resource. HELOCs are a viable method to unlock a cash flow that is held in your home’s equity. Consider these ways that a Home Equity Line of Credit may help prepare for or to live in retirement:
- It can be used to cover downturns in a stock market.
- It can be used to finance a rental property to increase one’s passive income.
- It can be used to fund a cash flow for retirees.
- It can be used to fund a second career.
A HELOC can also be used to renovate a property to make it more accessible for mobile-challenged family members. This is especially important for those homeowners whose physical needs have changed but do not want to move to another home or assisted living facility. As such, a HELOC can be used to add hand-rails in the bathroom, accessibility ramps, or the creation of a master suite on the first floor, to name a few.
- Whatever comes up.
One of the best things about a Home Equity Line of Credit is that the borrower decides when and if to use the available funds. So, if you, as a homeowner, open a line of credit, you are under no obligation to use that available funds at any time. A HELOC allows homeowners to prepare for unexpected expenses that may include-
- An emergency fund is recommended to be at least six months of living expenses.
- The financing of a new business venture.
- The ability to take time off for family or friends or to take a sabbatical from work.
An open home equity line of credit will provide peace of mind as borrowers have certain access to funding in the event of an emergency or other unexpected life event. The HELOCs flexibility provides a financial security blanket to the borrowers, who are now ready for whatever life may throw at them.
A home equity line of credit performs as a smart investment tool that many homeowners can use to help fund college, home improvements and provide a viable way to cover unexpected life events or emergencies. HELOCs allow homeowners to tap their equity rather than tap into their retirement fund to finance a new car or to pay for a new roof when damaged in a storm.