San Francisco Chronicle - (Sunday)
Your home has grown in value; should you get a HELOC?
Home prices surged to record heights over the past year, leaving some new homeowners in an enviable spot — suddenly sitting on a lot of equity, just a few months or years after purchasing their homes.
Equity is the current value of your home, minus what you owe. It’s one of your most important tools for building wealth, but unlike your cash in the bank, this facet of your wealth is tied up in an asset. One way homeowners can tap into that wealth is by getting a home equity line of credit, or HELOC. This second mortgage unlocks some of the equity in your home, letting you borrow as needed. How soon can a new homeowner get a HELOC? And when is it a good idea?
You could qualify within your first year in the home
Many lenders, such as Citizens Bank, have a six-month waiting period before you can apply for a HELOC. But Adam Boyd, head of home equity lending at Citizens Bank, says that the current booming environment has the bank “evaluating whether that policy still makes sense.” Shop around with at least three different lenders and ask how soon after a home purchase you can qualify.
In any case, you’ll have to meet additional requirements:
15% equity, but preferably 20% or more. To calculate this figure, find the current value of your home. Divide your remaining mortgage balance by the home’s current value, and subtract this number from one. For example, if your home is worth $400,000 and your mortgage balance is $300,000, you’ve got 25% equity (or $100,000) in the home.
A debt-to-income ratio below 43%. This number is the total of all of your regular monthly payments — such as your car payment, student loans and credit card minimums — divided by your gross monthly income.
A credit score over 620. Borrowers with scores of 700 or higher are more likely to qualify for the best rates.
You may need to get a reappraisal of the home. If you originally bought your home with less than 20% down, you’re probably paying private mortgage insurance. If the new appraisal finds that your equity stake now exceeds 20%, you can ask your servicer to end these payments. Even if you don’t get a HELOC,
eliminating this monthly expense is advantageous.
“If there’s significant equity, and it’s for a purpose that has merit, it’s a very reasonable strategy,” says Avallone. “If it’s for lifestyle and experience, however, that’s a different matter.”
Another good reason to get a HELOC is to use it as an emergency fund. If most of your savings went toward buying your home, a HELOC offers quick access to cash in the event of an unexpected expense.
Using a HELOC for an emergency fund may also free up your existing savings for other investments.
“I’ve actually had some clients that are interested in buying I bonds,” says Jake
Northrup, a certified financial planner. His clients have invested some of their savings in government bonds with the thinking that they can lean on their HELOC for a year in case of emergency.
What it makes sense to use your equity for
Mark Avallone, president of Potomac Wealth Advisors, cautions homeowners to not indiscriminately use the home as a piggy bank. Prioritize using your HELOC for purchases that offer a return on investment and leave you in a better financial position, like adding to the value of your home through renovations or repairs. A fancy vacation or a new car? Not so much.
Like any other mortgage,
HELOCs can have a weekslong closing process. If you plan to use a HELOC as an emergency fund, you’ll want to apply before anything goes wrong; that way, you can access the funds as soon as you need them.
When to wait to get a HELOC?
Some homeowners could be better off waiting a little longer to get a HELOC, Boyd says. For example, if you’ve just transitioned from renting, you’ll want to get comfortable with the new costs associated with homeownership and make sure you’re secure in your existing monthly expenses.
HELOCs are often offered at better rates than personal loans because you’re securing the loan with your home, risking foreclosure if you can’t pay.
You may also consider waiting on a HELOC until you can qualify for a higher loan limit, because your rate offers will likely be lower. For example, if you think that you’ll need around $50,000, you may be tempted to apply for a HELOC as soon as you can qualify for that amount. However, your rate could be lower if you wait until you can qualify for a $100,000 loan limit. You only repay what you withdraw, plus interest and any fees, so you can benefit from the lower annual percentage rate while taking out just the amount that you actually need.
Growing equity represents growing wealth, so you might choose not to borrow against it. Assess your reasons for wanting to tap your equity, and consider the way a HELOC would affect your financial future.