Today, will be our last installment in the mini-series on why home ownership is a pillar upon which you should build your financial future. If you missed Part One or Part Deux, those are required reading so hit the browser brakes and reverse on back to those other two posts.
- Borrow via Home Equity Line of Credit (HELOC)
Alright, so borrowing by opening a home equity line of credit is something I don’t typically advocate, but it can be beneficial in the right circumstances. So here are the basics on HELOCs. Typically, you have to own at least 20% of your home (i.e. have 20% home equity). A HELOC is secured by your home. You don’t pay, you lose home. The interest rates on a HELOC are much lower than a credit card. However, they are typically variable rate which means that if interest rates increase, then the interest you owe on the balance will increase, and thus, your monthly payment will increase. I did a quick search and saw HELOC rates around 5.5%. Again, these are variable so they can increase.
The ability to access your home equity via a HELOC is extremely helpful for a variety of financial samurai ninja moves. One, you can remodel your home by using your home equity. The interest you pay is deductible, and it is usually much lower than a credit card interest rate. Depending on your remodel, you may be able to create additional equity in your home by paying $15,000 to increase the value of the property by $20,000.
A second ninja move is to pay off high interest rate debt with the HELOC. This is relatively straight forward, move credit card balances to the HELOC so you pay 5.5% interest (deductible) instead of 15.5% (non-deductible). Granted, you may not want to do this if you plan not to pay the debt off, in which case you’d be putting your house at risk when you could just file bankruptcy and get the credit card debt discharged. That is called converting unsecured debt to secured debt. That is no bueno if you can’t or don’t intend to pay back the debt. That’ll have to get tackled in another post.
Third, again, not advocating this, but you could borrow to invest in assets that will appreciate more quickly than the HELOC interest rate. If you could take $50,000 and earn 10%, that’d be $5,000. You’d then pay capital gains tax of 20% so $1,000 to the tax man. In the meantime, the interest on the HELOC for the year might be 5.5% multiplied by $50,000, so $2,750. However, as we learned above, we would save taxes of $2,750 * 25% (tax rate) = $687.50. After all is said and done, we will have earned $5,000 and paid $3,062.50 leaving us $1,937.50 dollars richer! That’s not bad, but keep in mind it does come with investment/market risk (i.e. what if you don’t earn anything or worse you lose some of that $50k in the market). In short, I close with this, I am not advocating his, but it is an option.
Last, it is available for emergencies when you might need cash unexpectedly. You know, the Russian mobster calls your cell phone and says, “if you don’t pay $50,000 or boost 100 exotic cars in 24 hours your brother is dead.” I mean you just never know what might happen.
- Your Home is Protected from Creditors
This is something that you hopefully don’t know. Your home is protected from creditors. What that means is if you owe someone money, they typically can’t take your house to get paid. Now there are some exceptions to this. As we discussed early, if the someone you owe secured the loan with a deed to your house, then they can foreclose. But credit card companies, medical systems/hospitals, that jogger your dog bit causing him rabies and ultimately death, none of them can force a sale of your home to get paid. This is awesome because it means you will continue to have a place to rest easy after another of those panic attack inducing phone calls from a creditor.
Ok, so for the limitations on this protection. The protection is typically not unlimited. In Washington, your home equity is protected up to $125,000. This means if you have equity in your home in excess of say $125,000 and you owe someone $20,000, then they might try and force a sale of your home in order to get paid. If you only have $120,000 of equity, then that possibility is essentially non-existent. However, there are some states that protect 100% of your home equity, such as Arkansas, Florida, Iowa, Kansas, and Oklahoma. Even these states typically limit the size of your property that can be exempt (i.e. unlimited value but only up to ¼ acre in size). If you have a specific question on this, talk to your lawyer.
The key takeaway is that your hard earned equity is protected from future creditors. If you have existing creditors, talk to a lawyer.
In short, owning a home is a way to force yourself to save. Historically, a home beats inflation so that is a win. Moreover, you can borrow a significant portion of the money you need to buy the home. However, limit yourself to buying what you absolutely need and investing the difference in stock because the rates of return are much higher. In the meantime, know that your home is providing you social benefits, home equity you can access if you need to, and protection from creditors. At the end of 30 years, most renters have paid a lot of money to landlords and have no assets to show for it. For that reason alone, make it a primary goal to buy a house. If you need help with this, let me know because I will try to help in any way possible including connecting you with people who can help you more than myself.