“Bridge the Gap” when you need extra funds
Posted on August 31, 2015 by bob in MoneyWise
Advisors recommend having an emergency fund because financial needs can pop up unexpectedly from time to time. Sometimes, though, that reserve fund may be insufficient or may have been depleted by an earlier need. What to do? If you cannot postpone the spending until you save the needed money, borrowing is the usual course of action.
While gratuitous borrowing is a bad habit to get into, the use of debt is necessary for most people at some time or other. But not all borrowing is created equal. It makes sense, therefore, to wisely choose the lender and type of loan.
For those who qualify, a home equity line of credit (HELOC) can be a useful financial tool. Here are some things to be aware of in selecting a HELOC.
— The amount of the credit line will depend on the value of your house, how much you owe on it, and how stable the lender thinks the value will be.
— If approved, the HELOC will have a maximum amount that you borrow. You do not have to borrow the full amount.
— Like a mortgage, a HELOC has closing costs, although these are generally lower than for a first mortgage, and may be fully or partially waived in some cases. It pays to shop around.
— The HELOC carries a variable interest rate, so the cost of borrowing may change over time with the level of interest rates.
— Unlike a traditional mortgage, a HELOC is flexible. You do not have to withdraw the entire HELOC balance at closing. You can borrow some of the money, repay some, borrow again later, repay some more, etc., all under the same loan. The unused portion of the credit line is usually available whenever you need it. However, the lender can freeze a credit line, for instance, if it believes the value of your house has dropped.
— Most HELOCS have a 20-year term, with no principal payments being required during the first 10 years.
— Unlike auto loan or credit card interest, HELOC interest is deductible for taxpayers who itemize deductions.
Remember these cautions if you use a HELOC.
— Borrow for significant situations when your emergency fund isn’t enough—replacing a roof or major car repairs. Avoid using it like an ATM or to cover routine spending. I used one to pay college tuition twice a year while two sons were in college simultaneously.
— Repay principal as soon as funds are available, even though principal payments may not be required. I generally paid down the balance by the end of each semester.
— Remember that a HELOC is a mortgage. Default can result in your house being foreclosed. Don’t presume on the future by expecting the value of your property to stay ahead of the HELOC balance by appreciating indefinitely.
— Like other forms of debt, a HELOC can be a trap for the person unable to exercise self-control. If impulse spending or the overuse of credit cards is a problem, you may be better off without a HELOC. It might simply be a temptation to persist in self-destructive behavior and dig yourself into a deeper hole.
For the right people HELOCs can help bridge financial gaps that arise when spending requirements exceed available resources. Just be sure to shop for the best deal and use your HELOC with discretion.
Alan Wallace
Alan Wallace, CFA, ChFC, CLU, is a Senior Private Wealth Advisor for Ronald Blue & Co.’s Montgomery office, www.ronblue.com/location-al. He can be reached at 334-270-5960, or by e-mail at alan.wallace@ronblue.com.
