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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.
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 2004.
- 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.
August 2007 — This column is produced by the Financial
Planning Association, the membership organization for the
financial planning community, and is provided by Don McCarty of
Financial Decision Partners, a local member of the FPA.
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