When it comes to your financial stability, planning ahead is essential. A home-equity line of credit can give you an added level of financial security for the future and is best considered while you're in a healthy financial position.
Having an open line of credit on your house can be a valuable tool. It serves as a cash insurance policy, giving you financial flexibility when and should you need it, at nominal costs of securing capital. A HELOC gives you the ability to draw upon the value of your home, but you're never obligated to do so. You can simply pay an annual fee to know that you have access, if needed, without incurring debt. When might a HELOC be of use?
Finance home improvements.The most common and generally intended use of a HELOC is to finance home improvements. In fact, the interest you pay on a home equity loan is typically only tax-deductible if you use the money for home-related purposes. If you're thinking about borrowing to fund home improvements or repairs and anticipate paying off the amount in a short time frame, drawing upon your HELOC might be the best choice.
However, if you're unsure about paying down the balance within a five-year period, you might be better off refinancing your home to secure a lower, fixed interest rate.
Cover emergency expenses or consolidate debt. Ideally, you have an emergency fund available to cover large, unanticipated expenses. If not, and particularly if you have other debts, your HELOC could be an appropriate way to access capital. The interest might not be deductible if the loan exceeds $100,000 ($50,000 if you're married, filing separately), but it's typically at lower rates than other debt vehicles. Paying interest might also be cheaper than incurring capital gains by selling investments, especially if the funds are only needed for a short period of time.
If you're thinking of moving. A home equity loan can offer the liquidity you might need for a down payment on a new house or to cover the basic expenses related to buying and selling your property. However, it's important to note that you typically can't get a home equity loan once your house is listed for sale, so be sure to apply and draw against your HELOC before staking the For Sale sign in your front yard.
If you lose your job. One important reason to consider obtaining a HELOC is to provide for you and your family in the event you lose your job. It can pay to have a line of credit available in advance, just in case. People often scramble to obtain a HELOC when they lose their job, but unfortunately it's typically too late, as you must have secure income to qualify.
Should you need to move out of your home. Another qualifying factor to obtaining a HELOC is that you're currently residing in your home. If you suddenly encounter a family or housing crisis and are no longer able to live there, obtaining a loan could become problematic, during what's already a challenging time. Again, planning ahead can ensure you have the security of a home-equity line of credit available should you need it.
Bulk of savings in retirement accounts. Most Americans hold the bulk of their savings in retirement accounts, such as individual retirement accounts and 401(k) plans. Withdrawals from such accounts are subject to ordinary income taxes, plus possible penalties if you're under age 59½.
This makes taking money out for short-term expenses all the more costly. If your net worth is predominantly in qualified retirement accounts and you need capital while you're still working, a HELOC might be the best solution if you're able to repay it in a timely fashion.
Value of house declines. Finally, an uncommon but certainly plausible reason for why you might benefit from establishing a HELOC now is if the value of your home declines in the future. While home values typically rise, every asset goes through market cycles, and banks were quick to pull back on home equity loans during the last housing crisis. As with other aspects of your finances, it's best to be prepared.
Your house is typically your largest, or at least one of your largest, assets. It provides a home as well as security. It's important to take it into account when examining your overall financial planning. Make sure you're working with a qualified certified financial planner professional who advises on all of your assets, including your house and protective strategies, as part of a comprehensive financial-planning process.
(Editor's note: This article originally appeared on Investopedia.com.)
— By Jennifer E. Myers, president of SageVest Wealth Management
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