If you were involved in real estate when the market collapsed in 2008, you know the impact that HELOCs had on the market. Many homeowners thought their properties would never stop appreciating and leveraged their homes on a tilt. Once values declined and income stopped coming in, paying these obligations became tougher and eventually led to foreclosure. Fast forward six years later and we are once again seeing a return in popularity of the home equity line of credit (HELOC). While this may be viewed as a good thing for many investors, caution should be exercised.
A HELOC is a second mortgage based on the value of the property. The first mortgage stays in place with a new mortgage behind it. Lenders have still not budged on the cumulative loan to value they will lend on these types of loans, with the maximum around 75-80% of the appraised value. If you and your property are eligible HELOC candidates, there are a lot of good uses for this type of loan. The money is based on the prime rate with the first ten years repaid in interest only. This is a significantly lower payment than most credit cards, sba loans, private money loans and traditional mortgages. The problem arises when there is a change in the payment.
The loan term is typically twenty years, with the first ten focusing primarily on interest and the remaining ten on the principal balance. This could cause a significant, and sometimes unexpected, increase in payment. The loan is also based on the prime rate which is still just off all-time lows and bound to adjust upwards in the near future. If you are putting your HELOC money to good uses, such as buying other properties, home improvements or consolidating debt, you are taking advantage of your equity in a good way. If you are just taking the money out with no real purpose, you will end up regretting you ever set the line up in the first place.
Much like a credit card works, you only repay on your HELOC what you take out. If you withdraw $10,000, you only pay on that money and not what your line is for. This allows you to keep your line open and only use it when you have a specific purpose. The downside is that it is readily available and all you have to do is withdraw the money and use it however you please. If you keep your eye on your business and your overall financial profile, you can take advantage of your HELOC and make your money work for you. If you are not disciplined and take a little bit out here and a little out there, you will quickly eat away at your equity. When the market shifts, you will be left wondering where all your money went.
The guidelines make getting a line of credit difficult. In addition to having equity, the credit score requirement is very high and strict guidelines apply to the property type. Before you start thinking about the ways you are going to spend your money, remember what happened just five or so years ago. You may want to save your equity until you really need it.