Homeowners may want to grab this emergency lifeline before it dries up
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If you own a home and are looking for emergency financing, you may be running out of opportunities.
Home equity lines of credit allow you to borrow against the equity you’ve built up in your home, whether it’s for an unforeseen cash flow or for home renovations.
HELOCs are a revolving line of credit, which means that once you open it you can use it in a pinch – say, you lose your job – pay it off later and keep the line open.
Some banks are getting nervous about expanding HELOCs amid the economic uncertainty surrounding the coronavirus pandemic. In April, Wells Fargo and JPMorgan Chase temporarily interrupted applications for those lines of credit.
“I think the banks are clearly on a proactive approach, saying ‘Hey, we’re going to get a flood of applicants,’” said Doug Boneparth, chartered financial planner and president of Bone Fide Wealth in New York City.
“If you have this massive demand for setting up lines of credit, you, as the finance manager of a company, will be careful about opening the books to everyone – it’s probably too risky,” did he declare. “The bank feels the same way of uncertainty.”
Even if you were to get a HELOC, there is still no guarantee that a bank will not freeze the line in the future – or that it could reduce the amount of credit available to you, said Greg McBride, analyst. Chief Financial Officer at Bankrate.com.
This means that maybe now is the best time to buy a HELOC, so that you at least have the option available.
A strong emergency fund – which can cover at least three to six months of expenses – should be where you run into financial shock, including unemployment or cost surprises.
Beyond that, a taxable brokerage account, in which you sell a portion of your fixed income holdings, could come in second at a pinch, Boneparth said.
A HELOC would come third in the list of options for rainy days, he said.
Right now, the average interest rate on this type of credit is 4.86%, according to Bankrate.com. Meanwhile, credit cards charge an average rate of 16.32%.
HELOCs also enjoy some limited tax benefits, but only if you use them for buy, build or significantly improve the housing that secures the loan.
You cannot claim the HELOC interest deduction if you are using the line of credit to get out of unemployment or to consolidate your debt.
Interest on a HELOC is generally only tax deductible if you are using the money to finance home renovations – one of the reasons a home equity line is most often used for this purpose.
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If you’re adding emergency funding to your arsenal, it might not hurt to apply for a HELOC and leave it untapped until you need it. Just be aware of a few things before you commit.
• Know the terms of the drawing: HELOCs generally have a drawdown period during which you can borrow against the equity in your home. Once the drawdown period is over, you start repaying the loan.
Some lenders require HELOC applicants to take a minimum drawdown soon after opening the line – and that might not match your plans.
“If you’re setting it up as an emergency line of credit, avoid offers that require a minimum drawdown at close,” McBride told Bankrate.com.
• Watch for this interest: Before opening a line of credit, think about how you will pay off what you borrow in the future.
Is the interest on your HELOC fixed or variable? Do you plan to pay it off on a monthly basis or do you make a lump sum payment – a large sum at a later date? These are a few things to consider when you are evaluating the offers.
• Keep an eye on the costs: Getting a HELOC is not that different from getting a regular mortgage. Prepare for expenses related to valuing your home, as well as administration, closing and other fees.
“You’ll have processing times, an upfront fee, the ability to review, and then a three-day cancellation period before you can get your money back,” McBride said.