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 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
McGuire & Co., LLC, a local member of the FPA.
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