A Home Equity Line of Credit (HELOC) is an open line of credit that uses your home equity as collateral. Used correctly, this can be a great tool for building wealth. Read on to hear more about it!
The application process
You can get a HELOC at most banks and credit unions, but in many cases, local lenders will be your best bet. Once you’ve identified a good lender, you fill out the application and provide your normal financial documents (W-2, pay stub, etc.) just like you do with a mortgage application. Once this is done, the package is sent to underwriting where they make a decision on your credit worthiness, the home value, and some other factors. All-in-all, this process can take around 30-45 days.
A huge perk of HELOCs is the ultra-low closing costs. For my HELOC, I have ZERO out of pocket costs, including the home appraisal. This is one huge benefit over traditional mortgages or even cash-out refinancing.
Structure of a HELOC
The application process for the loan probably sounded just like a mortgage to you, but this is where the similarities stop. Unlike a mortgage which has a 15 or 30-year fixed term (normally), the HELOC has a 10 or 15 year term with interest only payments. HELOCs normally have a slightly higher interest rate than traditional mortgages, and they’re variable. In my case, my estimated HELOC rate is 5.25%, and that will vary accordingly with the interest rate set by the Federal Reserve.
You also only pay interest on the money you actually use. Let’s say you have a HELOC for $200k and you haven’t used it for 6 months. Your current payment is nothing. You find a great real estate deal which requires a $40k down payment, so you use the HELOC to fund this. After using $40k of the $200k, your monthly interest-only payment will be approximately $175. You heard that right… you can use $40k of someone else’s money and only have a monthly payment of $175. If you’re curious what your monthly payment would be, check out this calculator!
Don’t forget, if you carry this $40k in debt all the way until your 10 or 15-year term is up, the bank will call the loan, or in other words, demand you satisfy the total debt. You’ll want to keep track of this timeline.
Best uses for a HELOC
HELOCs are very versatile, in that the lender does not care what you use it for. Common uses are home improvements such as a swimming pool or renovation, real estate down payments, flipping houses, starting a business, and many more examples, including some questionable ones.
The other line of thought is to use the HELOC as an emergency fund. As you probably know, I have a love/hate relationship with emergency funds anyhow. I feel that they’re a waste of savings because they earn absolutely nothing (yes, I consider .7% absolutely nothing, but you continue earning those pennies you big saver, you!)
My real estate goals
My target use is real estate. This line of credit gives me tons of leverage against the equity in my current home, something which AJ Sheff recently talked about extensively! Instead of that equity just sitting there, and doing absolutely nothing for me, I’m going to leverage it to increase my rental portfolio.
By having the HELOC, I can avoid having to sell stocks (potentially at a loss) for down payment funds. I also have enough money in the HELOC that I could potentially buy a $1M investment, which is bigger than I ever dreamed of just a few years back. In other words, this product can open big doors!
My specific methodology is that the HELOC can buy me at least three $250k duplexes. Yes, I would have around $180k in extra debt after those purchases, but don’t sweat it! In the next couple of years, I would plan to use the appreciation on the homes to refinance at a lower interest rate. This would accomplish several things, but most notably, lower the interest I’m paying and free up my HELOC for future purchases. This cycle can continue in perpetuity.
A word of caution
We all have a different mindset when it comes to money, but I’d be negligent if I didn’t caution you against using a HELOC to buy shorts against TSLA or whatever your favorite “day trading” stock is. This is a recipe for disaster, and if you can’t recognize that, you should probably visit Wallstreet Bets on Reddit to satisfy that urge.
With that being said, a HELOC is a wonderful tool, but like anything else, needs to be used responsibly!