Using a Home Equity Line of Credit (HELOC) to increase equity in your home faster
In the everevolving landscape of real estate and financial markets, it’s crucial to explore opportunities that can contribute to building equity in your home. A noteworthy avenue is the Home Equity Line of Credit or HELOC. While the 2008 recession saw many banks recalling their HELOCS, as the market improved, the HELOC became a valuable financial planning tool.
It’s important to note that utilizing a HELOC to build home equity isn’t a one-sizefits-all approach. Success in this strategy requires discipline, a welldefined structure, and a steadfast commitment to a specific goal.
“What is a HELOC?” you might ask. A HELOC is a simple interest, open-ended line of credit secured by your home. You only pay interest on the balance remaining at the end of each day. Each time you pay the principal down, the interest and payment due are calculated on the remaining balance. In other words, the payment goes down each time you make a principal reduction payment. A unique feature: should you require funds that you’ve previously paid down, you have the flexibility to access them in case of an emergency.
Terms of HELOCS vary from year to year and from bank to bank. In general, the HELOC you are shopping for should be a firstposition loan and open-ended, so money can flow in and out. Usually, HELOCS are variable-rate loans keyed to an index such as the prime rate. The length of term can vary, but 10 years works very well.
Since I first wrote this article a few years back, the HELOC market has evolved. I asked Jodi Showman from CMG Mortgage, what type of product was available in today’s market. I was happy to learn that the exact product needed to perfectly execute the plan suggested below is now available. You can find all the details of this program at: https://www.cmghomeloans.com/ mysite/jodi-showman/all-in-one.
On a typical 30-year mortgage, if you make extra principal payments, your next month’s mortgage payment won’t change. However, the length of the mortgage is shortened every time you make that extra principal payment. You can create your own amortization schedule, and pay the extra amount to get your loan paid off by your goal. If you don’t make any extra payments, the loan payoff schedule for a 30-year, 6% loan would look like the graph below:
I like to use the 6% graph as it keeps the math easier, to understand the overall concept. It is also about the current rate for 30-year mortgages. As you study the graph above, you see that very little principal is paid in the early life of the loan. The principal reduction starts to kick in at about year 14. This is what you need to consider if you are thinking of refinancing an old loan. Your payment might go lower, but you are likely tacking years of loan payments onto the end of the loan. In today’s world, you might be able to ask for a “recast”, which prevents you from starting over with a 30-year amortization.
For purposes of this example, let’s compare an idea using a HELOC instead of the conventional 1st mortgage. In the interest of simplicity, in this example, we will use 6% for the interest rate. The idea consists of you using your HELOC as your checking account. Let’s say you have $5,000 per month income and your expenses are $4,000. The $1,000 difference is applied to the HELOC each month or $12,000 per year. Interest on the $100,000 and 6% for the year is $6,000. It will be a little less since the balance goes down each month. That leaves $6,000 to go towards principal reduction. Compare that to the graph above where the principal is reduced by $1,228. This only works, of course, if your income exceeds expenses monthly.
If your goal is to get your home mortgage paid off, this is a great way to do it. However, it is not without some risk. The risk is that HELOCS have variable interest rates keyed to an index. Because of the rapid principal reduction in this plan, rates going up a little won’t matter much. The other risk is if the banks start calling in lines of credit like they did in the last recession. Again, this plan isn’t for everyone, but for the right situation and with the proper advice from the bank and any other financial advisors, it can be a great tool to build your equity.