Published November 9, 2023
Got Equity? Look Into A HELOC
Ever since COVID hit and people began to work from home, I've been getting a lot of questions about renovations, additions, and ADU's. There comes a time when the dirt your house sits on becomes so valuable that it can make more sense to add onto a home then sell and buy a new one. Just drive around neighborhoods in Durham like Lakewood, Old West Durham, Watts-Hillandale, Trinity Park etc. and take note of how many homes have additions. That's because it might make sense to build an addition on your home for $250/sqft knowing that as soon as it's finished it's going to be worth $350/sqft or more.
But how do I do that?
When people look back on interest rates the last couple of years, they often talk about how so many buyers entered the market because money was cheap. People who couldn't afford a mortgage suddenly could when the interest rate was 3%. People starting moving and buying homes just because they wanted to and they could, not because they NEEDED to. However; there was another phenomenon happening at the same time which is that many people were refinancing their loans. Mortgage brokers were hiring extra staff just to manage all the refinances that were landing on their desk.
The reason I bring that up is because when interest rates were low, a common idea was to do what's called a cash out refinance. For easy math let's say you bought your house back in 2017 for $200k and in 2021 it was worth $400k (congratulations by the way). When you went to refinance you had a $150k mortgage on the property. In the simplest terms, you would get a new loan for $400k, pay off the original $150k loan and take the $250k out in cash. The explanation above is for simplicity and does not take into account refinance costs, and keep in mind most banks will only allow you to take 80% of the cash out. Also keep in mind that if you do this, your mortgage payment is going to be higher because in this scenario, your loan amount is higher. That being said, it was a really great option for folks who wanted to tap into the equity in their home and use it for renovations, debt consolidation, or to purchase an investment property or vacation home.
So what's a HELOC?
HELOC stands for a Home Equity Line of Credit. Which is essentially a secured line of credit against the equity you have in your home. They are much less expensive then doing a cash out refinance and you only pay if you have a balance. It's a simple process compared to a cash out refinance and since it is a secured line of credit, you could use that to do renovations to your home OR as a down payment on an investment property (unlike a credit card which is an UNSECURED credit line). While the rate is typically higher on a HELOC, remember you only have a monthly payment if you carry a balance. When you get a HELOC, the bank puts a second lien on the property that needs to be paid or satisfied before you can sell the property. That's why it is considered a "secured" line of credit
There are pros and cons to both of these products and I'm not saying one is better than the other. It just depends on your goal. If you want to do a $50k renovation to your home, it may not make sense to get a whole new mortgage at today's interest rates if you have something locked in at 3% or 4%. In that case, a HELOC may be the better route and you can work quickly to pay it off.
What SHOULDN'T I Use a HELOC For?
I would be remiss if I didn't end this newsletter with a warning about both of these products. They only make sense if they make cents. See what I did there? It might make sense to use either one of these products to consolidate high interest debt. However; you have to be on a clear and determined path to get out of debt as quickly as possible because this is the equity in the home you're playing with. It might make sense to use a HELOC to do repairs and improvements that will IMPROVE the value of your home. Or to purchase a cash flowing investment property or to do a flip. It DOES NOT make sense to take out a HELOC to go to Disney World or buy a car or I don't know...go into more debt.
If you want more information on either of these products, I'm happy to connect you with some experts on the subject matter. I have a HELOC through Coastal Credit Union. You can find out about their HELOC product here. I'm not endorsing them in any way, although; I would be happy to share my experience if you were interested. Stay cool this weekend.
Be Smart. Be Safe. Be Content
