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If your emergency funds need a boost, consider going home.
A home equity line of credit — a loan secured by your home — could be a quick source of emergency cash, provided you use it responsibly.
“The only good thing about HELOCs is that the interest is at a better rate than what you would get on personal loans and credit cards,” certified financial planner Douglas Boneparth, president of Bone Fide Wealth, told New York.
Indeed, interest rates on HELOCs are currently between 4.25% and 6%, according to Lending Tree. Meanwhile, average credit card interest rates hover around 17% and personal loans can carry rates in excess of 6%, according to Bankrate.com.
“It’s an attractive rate compared to other credit products, and it’s relatively easy to get if you have decent credit,” Boneparth said.
About a quarter of homeowners who took out a HELOC opened the line to meet emergency expenses, including car repairs and medical bills, according to a NerdWallet survey.
The personal finance site, in conjunction with Harris Poll, surveyed 2,043 adults online in March.
About 1 in 8 borrowers took out a HELOC to protect themselves in the event of unemployment, NerdWallet found.
Here’s what you need to know if you’re considering leveraging your home equity to build your reserves.
Costs and fees
A couple sit down with a mortgage consultant in Miami.
Don’t just go to the lender who gave you your mortgage. Instead, look for competitive interest rates, which are usually adjustable.
Some lenders also offer a hybrid HELOC, which will let you earmark a portion of the loan for a specific purpose and set a fixed interest rate on the amount borrowed, said Holden Lewis, mortgage analyst for NerdWallet.
Under this arrangement, you are expected to repay that installment of the loan within a specified number of years.
Know that it’s not just the interest rate in your loan.
For example, banks may charge a variety of fees, including line of credit non-use fees, annual fees, and lender expenses.
Some HELOCs also require you to draw on your line of credit immediately or they may require you to maintain a revolving balance on the line for a specified period of time, NerdWallet’s Lewis said.
Keep this in mind when shopping for loans and consider the purpose of your HELOC.
“Open a line of credit that won’t charge you interest unless you use it, one that won’t charge you an annual fee or only a nominal fee where you’re willing to pay for more flexibility,” he said. said Boneparth.
Before taking out a loan, think about how the repayment will fit into your cash flow if you start using the credit.
HELOCs generally have two phases: the drawdown period – the time you can withdraw money from the line of credit – and the repayment period.
Often, the drawdown period is around 10 years, according to Lewis of NerdWallet. During this period, owners can make minimum interest-only payments.
This means that these borrowers could be in for a nasty surprise at the end of the drawdown period.
In this case, the monthly payments will increase sharply as you begin to cover interest and principal on the amount you have borrowed.
“Any type of credit instrument, when used responsibly, can be a useful tool,” said Boneparth of Bone Fide Wealth. “When used irresponsibly, it’s the stuff of horror stories.”
Be aware of your debt to income ratio and how a large increase in HELOC repayments will affect your cash flow.
The general rule is that no more than 36% of your gross monthly income should be spent on paying down debt, including credit cards, your mortgage, and other loans.
Change in tax treatment
Photo by Rolf Bruderer via Getty Images
Finally, if you’re using your HELOC for reasons other than replacing your roof or gutting your kitchen, know that you’ll likely miss out on tax relief.
Before the Tax Cuts and Jobs Act, you could deduct interest paid on up to $100,000 of home equity lines of credit and home equity loans, regardless of how you used it. ‘money.
Now you can only deduct interest if you use the loan to improve your home.
Starting in 2018, taxpayers can only deduct interest on up to $750,000 of qualifying home loans. This applies to the combined amount of loans you use to buy, build or significantly improve your home – this includes your mortgage and your HELOC.
“The rules of conventional thinking are to avoid withdrawing more than you need and to keep in mind changes in tax law and your ability to deduct interest,” Boneparth said.
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