- Smart ways to use a HELOC are: for the down payment of a construction loan, for renovations with good ROI, for buying a second home, for funding investment properties and to consolidate debt.
A home equity line of credit, better known as a HELOC, can be an excellent avenue for helping clients achieve their dreams. But it’s essential that they be smart about how they use them.
For example, tapping into a home’s equity to purchase a piece of land for the downpayment on new construction is smart. But using it to install a luxury item, such as a pool, thinking there will be a return on the investment, may not be so bright.
Understanding the basics of a HELOC is key to explaining the advantages to a client.
Most lenders will allow an owner to borrow up to 90 percent of the appraised value of a home. For owners whose homes have appreciated, the amount of equity they may use toward the purchase of a new home or investment property can be substantial.
Most HELOCs are set up as a checking account. If you don’t use the money, you don’t have to pay for it. A HELOC balance rises and falls like a regular checking account.
Fees and interest are usually low on a HELOC, so they are affordable.
There is a difference between a HELOC (line of credit) and a Home Equity Loan (second mortgage). A Home Equity Loan usually works similar to your mortgage with a set amount and term of payments.
Here are five smart ways your clients can use the equity in their home to their advantage.
1. To finance the down payment of a construction loan
Many buyers want to build a new home but have a hard time coming up with the amount needed to purchase a homesite.
Most banks use the land equity as a down payment for the construction loan.
If your client doesn’t have cash lying around to buy the land, a home equity line of credit is a great option.
2. Renovations that may increase the value of a home
If a client is thinking about selling his or her home and would like to make some improvements first, a HELOC can be an excellent way to complete the renovations and possibly yield a higher sale price.
Kitchen and bath renovations usually yield the most value. But other items such as new siding and windows can be a good bet too.
3. Purchasing a vacation home
Tapping into the equity of a primary home can be an avenue for the purchase of a vacation or second home.
If the second home is in a popular vacation spot, clients may want to consider renting it when not in use to offset the cost of the second home.
4. Funding of investment properties
Clients interested in purchasing property as an investment can also tap into the equity of their primary home to fund the purchase. Be cautious though.
Many buyers underestimate the actual cost of a rental property. If this is your client’s first rental property, educate them on the real income potential.
5. To consolidate debt
Many times a potential buyer is just not quite able to qualify for a mortgage on a new home because of credit obligations such as car loans, student loans and high-interest credit cards.
Consolidating this debt with a HELOC can help bring down the debt to income ratio (DTI) so that a new home is possible.
Consolidating debt with a line of credit also allows a buyer to move into a new home without the baggage of old debt because a HELOC is paid off once their house sells.
The new tax laws have brought new regulations in regards to the tax advantages of HELOCs and home equity loans. Ask your clients to talk to an accountant prior to seeking this type of loan to fund a new property or project.