20 - All About HELOCs: Using Your Home's Equity Wisely

Your home has value you can use. With guest Megan Zielinski, VP/Area Executive, we explain the Home Equity Line of Credit (HELOC). In this episode, you’ll learn how to calculate your home's equity, how a HELOC's "draw" and "repayment" periods work, and the smart ways to use this powerful financial tool for things like home renovations. We'll also cover the important responsibilities and risks that come with borrowing against your home.

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Transcript

20 | All About HELOCs: Using Your Home's Equity Wisely

00:00:00 Daniel Hill: Shanna, picture a homeowner. They've been in their house for seven or eight years, diligently making their mortgage payments. The value of their home has gone up nicely over that time.  

00:00:14 Shanna Browning: Ah equity. They've been building that over that time and that's a great position to be in.

00:00:17 Daniel Hill: Exactly. And now they're thinking about a big project. Maybe it's a much needed kitchen remodel. Or maybe their oldest child is about to start college and they need help with tuition. They have this value locked up in their house, but they don't know the best way to access it.

00:00:33 Shanna Browning: Well, and it's a very common scenario. They need a large amount of cash, but they don't want to drain their savings, and they don't want to take out a high interest personal loan. And we definitely don't want to touch those 401Ks.

00:00:43 Daniel Hill: No, no. And for many homeowners, the solution could be a home equity line of credit or HELOC. But it's a tool that comes with a lot of questions. And today we're going to answer them. Welcome back to Making Sense of your Cents. I'm Daniel Hill.

00:01:09 Shanna Browning: Hi, friends. And I'm Shanna Browning. And today we're going to talk about a powerful financial tool available to many of you homeowners. And that's home equity lines of credit.

00:01:20 Daniel Hill: And to help us understand this topic, we're thrilled to welcome our mortgage expert, Megan Zielinski. She's our Vice President and Area Executive up here in Tazewell. Megan, welcome to the podcast.

00:01:32 Megan Zielinski: Thank you for having me. A HELOC is a natural next step in the home ownership journey, and I'm really happy to talk about it today.

00:01:38 Shanna Browning: Thanks, Megan. So let's start with the most basic definition. What is a home equity line of credit?

00:01:45 Megan Zielinski: A home equity line of credit, or more commonly called a HELOC, is a revolving line of credit that's secured by your house. The home equity part of that definition is key. Equity is the difference between what your home is worth and what you still owe on your first mortgage, if anything. A HELOC allows you to borrow against this equity.

00:02:02 Daniel Hill: So let's use a simple example. If my home is valued at three hundred thousand and I still owe two hundred thousand on my mortgage, I have about one hundred thousand in equity, right?

00:02:15 Megan Zielinski: Yes. That's correct. The bank would then use that equity to determine the maximum amount you can borrow. It's not the full one hundred thousand, it's a percentage of it though. Most often it's eighty percent would be your max minus the mortgage balance.

00:02:28 Shanna Browning: So you described it as a revolving line of credit. How is that different from a standard loan like a home equity loan?

00:02:37 Megan Zielinski: This is the most important part of the definition of a home equity line of credit. A traditional loan, sometimes called a home equity loan or a second mortgage, gives you a lump sum of cash up front. You get one check, and you have a fixed interest rate and a fixed payment for the life of the loan. A HELOC, however, works more like a credit card. Instead of a lump sum. The bank approves you for a credit limit, and then you can draw money from that line of credit as you need it up to the maximum amount. You're only required to pay interest on the amount that you've borrowed, not the total limit.

00:03:08 Shanna Browning: Well, that makes sense.

00:03:09 Daniel Hill: It really does. And so, Megan, if you're approved for a fifty thousand dollar HELOC for a kitchen remodel, you don't have to take all fifty thousand at once. You can pay the contractor for the cabinets, then pay the plumber, then the electrician - drawing the funds as the bills come in.

00:03:28 Megan Zielinski: Exactly that flexibility is the biggest advantage in having a HELOC, because if your project doesn't come in exactly like what you estimated upfront, you have that flexibility to use or not use it all.

00:03:41 Daniel Hill: Well that's good.

00:03:42 Shanna Browning: I like that. I mean, that's a great tool for homeowners. So when you take out a HELOC, it's not like a mortgage that has just one long repayment period. And there are distinct phases of that, right?

00:03:53 Megan Zielinski: Yes. A HELOC typically has two phases. The first is called a draw period. This is usually the first five to ten years of the HELOC. During this time, you borrow money from your line of credit as needed up to that maximum limit.

00:04:05 Daniel Hill: And and what are payments like during this draw period?

00:04:09 Megan Zielinski: During that period, your monthly payment is normally really low. It's going to be interest only on the amount that you've used. You can, of course, choose to pay more and pay down the principal. We do normally advise this, but the minimum required payment is only interest. This keeps the payments manageable while you're working on your projects.

00:04:27 Shanna Browning: I mean that's kind of a great tool.

00:04:28 Daniel Hill: Yeah.

00:04:29 Shanna Browning: You know, so what happens when you have that draw period end.

00:04:34 Megan Zielinski: When your draw period ends, you can't borrow any more money from the line of credit. It's essentially frozen. The HELOC would then enter the second phase, which is your repayment period. At this point, whatever balance you have outstanding is converted into fully amortizing loan. Your monthly payment is going to increase because you're now paying back both principal and interest. But again, this is only on the amount that you've used. The repayment period is typically ten to twenty years.

00:05:00 Daniel Hill: So it's important to point out that most HELOCs have a variable interest rate, right?

00:05:08 Megan Zielinski: Yes, and that is very important. The interest rate on a HELOC is usually tied to the prime rate. So as we discussed in our episode about the FED, when the Federal Reserve raises interest rates, the prime rate goes up and the interest rate on your HELOC will go up as well. This means your monthly payment will change over time. It's also going to vary monthly based on the amount of days in the month or the amount that you've used. If you use it throughout the month, your payment will go up on the next billing cycle.

00:05:34 Shanna Browning: Good to know. So now that we've established a HELOC is a really flexible, which I think is great and powerful, what are some of the smartest ways for homeowners to use one?

00:05:46 Megan Zielinski: The wisest use of use of HELOC is most most often for things that add value to your life or financial situation in the long run. The number one best use is for home improvements. When you use the equity in your home to fund a kitchen remodel or a new bathroom, you're often directly increasing the value of your home and investing in your biggest asset.

00:06:08 Daniel Hill: And what are some other smart uses?

00:06:12 Megan Zielinski: It can be a strategic tool for education expenses. The interest rate on a HELOC is often significantly lower than a private student loan. It can also be used for debt consolidation. We do see that a lot. If you have a lot of high interest credit card debt, you could use the HELOC, which would have a lower interest rate, ideally to pay off those balances and consolidate into one more manageable payment.

00:06:35 Shanna Browning: Man, those are some great tools. I like that. But as with the pros of some things, now there's a little bit of cons. And so there's things that we need to talk about that are kind of cautions. So because your home is the collateral that means there might be some risk involved, right?

00:06:53 Megan Zielinski: Yes, there is a risk. And the most important thing to understand about that is when you take out a HELOC, you are putting a lien on your home. A lot of the time, it's going to be a second lien scenario where you have a first mortgage and this is the second. So you are taking on two monthly payments with your house put up for the collateral. If for any reason you're unable to make the payments, the lender could, in a worst case scenario, foreclose on your property.

00:07:15 Daniel Hill: Oh, we don't like that word.

00:07:16 Shanna Browning: No.

00:07:17 Daniel Hill: So what you're saying is you should never use a HELOC for frivolous spending, for things that are for entertainment or not. Not something that's long term.

00:07:31 Megan Zielinski: Absolutely not. This is not a tool to go on a lavish vacation, buy an expensive car, cover day to day spending. I have seen people use it for something like purchasing a car, only to turn around and finance their car. They can use it for quick funding of a purchase, always with the intent to turn around and pay that balance back down when you get your full funding covered a different way. But typically you're going to use it for significant value adding expenses, and only if you have a clear and confident plan for how you're going to repay the money that you borrow. It's a responsibility that you should take very seriously.

00:08:05 Shanna Browning: Well, and I like that you said people can have that option. And that's the great thing about HELOCs they are options. So, Megan, you've really explained a really perfectly balanced overview of what we consider to be a complex topic for not only us as bankers, but as consumers as well. So now, Daniel, it's time for next week's actionable tip.

00:08:32 Daniel Hill: Your action item for this week is the Equity Explorer. If you're a homeowner, this is a simple, no commitment exercise to get a rough idea of the equity you might have in your home.

00:08:45 Shanna Browning: So what we talked about you might have a first mortgage. So go find your first most recent mortgage statement and look at your current principal balance. Your principal balance is what you owe part of the equation.

00:08:58 Daniel Hill: Second, get a rough estimate of your home's current value. This is easy to do. You can do it by looking online at a home value estimator like Zillow or Redfin. And now keep in mind these are just computer generated estimates, not an official appraisal. But they're a great starting point.

00:09:18 Shanna Browning: That's right. Not an official appraisal. So now just do the simple math. Subtract your mortgage balance from the estimated home value. That number is a rough ballpark estimate of your available equity.

00:09:32 Megan Zielinski: And that number is a foundation. It's a starting point for a conversation to get you started about what might be possible to fund projects for your home.

00:09:40 Daniel Hill: Exactly. You're not applying for anything. You're just gathering information and empowering yourself with a clear picture of your own financial position. It's a fantastic first step.

00:09:53 Shanna Browning: Megan, we've loved having you here. You're just a wealth of knowledge about this information, and we appreciate you just joining us and making it easy for our customers to understand and our listeners.

00:10:04 Megan Zielinski: Thank you guys so much for having me. This is a very important tool, and I'm glad we could talk about it and get some information about HELOCs covered.

00:10:10 Daniel Hill: Absolutely. And hey, be sure to join us next week. We're going to tackle a really important topic and that is banking for the next generation.

00:10:18 Shanna Browning: And we're excited to have Shelby Liford, who is our Branch Operations Coordinator, joining us to share her expertise with parents and teens. And you really don't want to miss that conversation.

00:10:28 Daniel Hill: Absolutely not. And that's all the time we have for this week. So on behalf of Shanna Browning and our guest Megan, I'm Daniel Hill.

00:10:35 Shanna Browning: Thanks for listening. And until next time, go out and make some sense of your cents.