HELOCs Explained

Speaker 1: [0:00] Hello, hello, and welcome to another episode of the Awesome in Seattle podcast. This is your host, Christian Awesome, of the Awesome Nossum Group at Wilson Realty, and today We are gonna give you a lot of information. We're gonna explain a way that you can use the equity in your home to work for you. Today, we're talking all about HELOCs. A HELOC stands for- Ooh, HELOC Yes, HELOC. Ooh, exciting. That stands for home equity line of credit. By understanding HELOCs, you can actually expand your real estate buying and investing power in a number of ways. You can also use a HELOC to consolidate debt or prepare for unexpected life events. Always use caution. This is not free money. Just throwing that out there right now. This is a big deal. It is a loan that you're getting, but, uh, yeah, use it responsibly. So get that out of the way. Before we get into the ins and outs, let me introduce the team. First off, we have the Seattle native, Ms. Reid Watson.

Speaker 2: [1:01] Hello. That's me.

Speaker 1: [1:03] We have the data guru, the one and only Mr. Jason Saldarriaga. Yo. I was gonna

Speaker 3: [1:09] say Ms. Jackson, if you're nasty again. I've been saying that a lot.

Speaker 1: [1:11] You've been saying it a lot, yes. And then we got the dog whisperer, Mr. Lester Cutting.

Speaker 4: [1:17] Les, if you're nasty.

Speaker 1: [1:18] Les, if you're nasty. All right. So before we get into the nitty-gritty, now that we're talking about being nasty, I want to take a moment to let our listener know, listeners know that we are not CPAs, we're not lenders, we're not finance experts. Apparently, I also- We are so much

Speaker 3: [1:33] more. No

Speaker 1: [1:34] We are, we are way, we are way more than that. Yeah. We're just- No, we- … lowly real estate agents.

Speaker 3: [1:39] Yeah.

Speaker 1: [1:40] Uh, but we're also investors, and so we're gonna share some of what we do, um, and how we use, uh, home equity lines of credit to, uh, to the fullest extent. So let's start with a question that many, or that may be on a lot of your minds right now, and what the heck is a HELOC? Well, simply, it stands for home equity line of credit, and that is just a line of credit you can secure using the equity in your home as collateral. Your home equity is calculated by subtracting what you owe on your mortgage from the market value of your home. And there's two ways that your home equity can grow. That's when you pay down your mortgage balance each month, and your home value can increase in value, creating a bigger and bigger amount of equity in your home. A simple way to look at this is a HELOC enables you to turn the equity in your home into cash, which you can then use for a number of things, including increasing the value of your home through a renovation, or putting the equity towards buying a, your next home, or an investment property, or other investments, or simply consolidating higher interest rate debt. Les, can you give our listeners a little insight into how a home equity line of credit, or a HELOC, works?

Speaker 4: [2:56] Absolutely. So I think it's important to point out the difference between a home equity loan and what we are talking about, a home equity line of credit. A home equity loan, it looks a lot like a regular mortgage, if you will. Versus a home equity line of credit, AKA a HELOC, which is more like a credit card. Unlike a loan, a line of credit you don't receive a set amount upfront. Instead, you have access to a certain amount that you can decide to use if you need it. Like a credit card, you start out with a credit limit. When you pay down that balance, the credit goes back up. So you can borrow against it again and again, but only up until your credit limit. The best thing about establishing a HELOC is that you can usually secure it at a lower interest rate, which is awesome, compared to any other type of loans or credit cards out there. Because the interest rate is usually a little bit lower, a HELOC is a phenomenal way to access low-cost funds, meaning that you pay less interest compared to other credit cards and any other conventional loans. The ability to access a HELOC is a huge, huge perk of owning a home, and making sound decisions when using one can help you increase your equity and the market value of your house. Adding value is something you always should think about when you own a property, so a HELOC is a great way to do that. Basically, a HELOC gives homeowners access to cash for large purchases like home improvements, renovations, debt consolidation, and investments. Like I said, when you pay down your balance, you can borrow again up to your credit limit, and depending on the lender, sometimes you can borrow up to 90% of the value of your home, minus the amount you owe on the property, which is huge.

Speaker 1: [4:34] Yeah. There's actually some lenders that will go up to 100% of your value of your home- Wow … which is kind of crazy, yeah. They're few and far between, but they are definitely out there. The amount of money that you can borrow is, like Les said, determined by the value of your home minus the amount of money that you owe on your home. So for an example, simple math, let's just say that you're gonna get a HELOC at 90% of your home's value. So again, simple math. If your home is worth a million dollars- And you currently owe $700,000, you may qualify to borrow up to 90% of your value, which would be $900,000. So that $900,000 limit minus what you owe, which is 700,000, that means you get $200,000 line of credit that you can use. Now, obviously the exact amount depends on your bank's combined loan-to-value ratio, or CLTV, and your mortgage lender or broker or bank will lead you through this discussion, will help you figure out all those things. If you guys need a referral to anyone or any of these banks, personally I keep track of who does these and who is currently offering some great terms. So feel free to reach out directly. All of our contact info is on our website, awesomeandawesome.com. Yeah, just reach out however you feel you want to. Call, email, text, whatever. So Jason, how does

Speaker 3: [5:59] a homeowner actually get a HELOC? So the first step is generally to sit down with your mortgage broker, your bank, your lender, what have you, and just see the line of credit that they can offer based on their requirements. Because keep in mind, HELOC requirements do vary from lender to lender. At the end of the day, it can pay off to shop around for the best interest rate and lowest overall cost. You do not have to go through the same company that handles your mortgage. A lot of people don't realize that. Um-

Speaker 2: [6:29] Hmm. That's good to know.

Speaker 3: [6:30] Yeah. Lenders will review The value of your home, the amount you owe on it, and of course, your credit history to determine the terms of what they can offer you. It is important to remember that if you don't repay the loan, you could lose your house. You know, that's high stakes. So take the time to find a HELOC with terms you can live with and meet, because you don't wanna commit to something that at the end of the day is gonna be hard to make work.

Speaker 1: [7:01] Taking the time to understand what interest rates and other fees are associated with a HELOC are obviously crucial. Often HELOC interest rates aren't fixed, they're actually variable, and some people assume that the entire amount paid in interest is deductible too. This is not always necessarily the case. If you're establishing a line of credit based on the equity in your house that you already own, you can only deduct the interest on the money used for renovations and improvements. Now, while this is great for improving a property, using the line of credit for other large expenses may not allow you to deduct this interest paid. Now, again, we are not a CPA, we are not a, uh, tax advisor, we are not a financial advisor, we do not give legal advice. So consult an expert in that field since r- rules do and often will change. So don't take my word for this. But to give you an idea of what rates are right now, there's a bank, a credit union actually called Obee, O-B-E-E Credit Union, and they are a local, you know, Seattle area. I think they're mostly based down in Tacoma. But they have some fantastic HELOC loan options. The interest rates vary up to how high you want your, uh, percentage to go For example, if you want your, if you wanna get up to 80% of your equity out, that interest rate is gonna be between 3 and 4% currently. Now, this is, you know, these change daily, but this is currently where they're at. If you're getting up to 90% loan-to-value, you're gonna be around 3.5 to 4.5%, and if you wanna do 100% of your home's value, that's gonna be closer to 6%. So the more you take out, the larger your line of credit is, the higher the interest rate is, because that's a little bit more risky for the bank. But that's how that works. Reid, what are some tips for homeowners that are considering different HELOC lenders?

Speaker 2: [8:53] Yeah, I got a few good ones.

Speaker 1: [8:55] Cool.

Speaker 2: [8:55] It's important to consider with anything in real estate, or even more generally, the total cost of establishing it. So especially with a HELOC, considering the total cost of establishing that HELOC. This includes the amount you'll have to pay back, the interest, other fees. When you're weighing your HELOC options, it may seem appealing to choose the lender that, obviously, that gives the largest credit limit, but that might not actually be your best option. So I have some good questions to ask when you're comparing HELOC options. So one that Christian mentioned is what is the interest rate? Is the interest rate fixed? A fixed rate makes your cost more predictable, but that fixed rate might be higher than other options that include a variable rate. So ask about that. Ask what are the closing costs. A lot of people only associate closing costs with primary mortgages, though most HELOCs require closing costs. So you wanna know what that cost is gonna be on top of everything else.

Speaker 1: [9:58] Yeah. I will say that HELOC closing costs are very minimal. Mm-hmm. Unlike when you're buying a home or refinancing, your closing costs could be, you know, between 1 and 2% of the loan amount. Right. Here, the closing costs are gonna be probably under $1,000 total, usually closer to $500. But it all depends on the bank and what they're- Right … charging you for. So-

Speaker 2: [10:19] Yeah … Speaker: just to give you an idea. And that kind of leads me into my next one: what other fees will you have to pay? One of the reasons that HELOCs can be preferable to a home equity loan is that, you know, they might be a little bit cheaper, and also you have more flexibility. You aren't locked into borrowing a certain amount or how soon you have to pay it off. And as a result of providing that flexibility, some lenders will include an additional fee to compensate.

Speaker 1: [10:45] Yeah. Those are all very important questions to ask. Uh, you don't wanna be surprised by those fees or- No … or if you didn't realize the interest rate isn't fixed and it's a variable and it's fluctuating all the time, which is gonna change your loan payment every month. That could, that could mess you up.

Speaker 2: [11:01] Mm-hmm.

Speaker 1: [11:01] Uh, Les, once you have secured a HELOC, what are some of the ways that you can put that money to use to increase your equity, or how can a homeowner put the money that they have invested in a property to work for them?

Speaker 4: [11:15] Okay. One of the best reasons to establish a HELOC is to have another real estate tool in your toolkit. Again, this is about leverage. You know, how can you leverage what you have now and make it work for you? So I'd like to reiterate this isn't free money. But you can literally turn the equity of your home, the amount you've paid off, into cash to remodel or a renovation. So again, you should always be thinking about adding value to what you own. That should be your, your goal whenever you purchase a property. Uh, whether you wanna update your home for resale or just simply create a more comfortable space for you and your family, a HELOC, like we said, is a great way to fund a project. One reason Christian already mentioned, the interest used for the renovation and improvements are often tax deductible, so that's huge. That's why a HELOC is oftentimes a better option than a credit card when it comes to remodeling or renovating. A HELOC can be used for debt consolidation. When you use it to pay off debt, like a credit card, your monthly amount due is based on what you spent, plus interest. And as we've said, interest rates on HELOCs are often lower than credit cards. So it, again, it makes sense. We aren't financial advisors, so get with your financial advisor and see if this can be an option for you

Speaker 1: [12:25] Yeah, that's a, that's a very good point. I mean, I, I know from talking with others and, you know, hearing stories that it sometimes makes sense to get a HELOC at a lower variable rate sometimes, or lock in that rate, which you are allowed to do with some banks, because the interest rate's going to be a lot less than the credit card payment that you have. Say you got 20 grand in credit card payments at 16% interest. If you can get a HELOC for 20 grand at 3% interest, you're gonna save a lot of money. So that's what you should definitely do. Maybe not definitely, but you should definitely look into doing that in order to save some money every single month. Reid, if you wanna sell your home and buy another house, how can we use a HELOC to make that happen? What's a good, what's a good strategy for that?

Speaker 2: [13:16] Yes. So a HELOC is a great way to turn the money you've invested into your current home into a down payment on your next home before you sell your current home. If the home equity of your first home covers the purchase price of your second home, a HELOC is most likely a cheaper option compared to taking out a whole another mortgage to buy a new home. You may be able to deduct the interest of up to $100,000 when you use a HELOC to purchase your next home, which is cool. If you use cash, you won't get that tax break. You could also use a HELOC to cover the down payment on an investment property or a second home. It's just important, again, to remember that this is a line of credit you're taking out of your first home, and you will need to pay it back.

Speaker 1: [14:02] Yeah, a good way to kinda use this as a investment tool or a strategy would be, say you, again, let's go back to our example. Let's say you have a million dollar home. You owe 700. You're getting a HELOC up to 90%, so you have that $200,000 home equity line of credit. Let's say that you need a down payment, a 20% down payment, on an investment property. You could use your cash, or you could use your home equity line of credit money as the down payment for that next home. If you were gonna sell your current home what, that you have the home equity line of credit on, obviously you need to pay that balance off. But you could use that down payment money or that home equity line of credit to get you that next property. Utilize the equity in your home to get you another investment property to hopefully make more money than what your monthly payment is on that next property with your home equity line of credit payment in there as well. All right, Jason, do you have any other creative suggestions on how a homeowner can utilize a HELOC?

Speaker 3: [15:04] Hmm. There's a couple, I think- … that come to mind. I will say, clients have increased the value of their home and increased their monthly income by using a HELOC in order to pay for the construction of a backyard cottage. We call these DADUs, which, uh, stands for detached accessory dwelling units. You may have heard of them. We talk about them regularly on this podcast. If you do want more info on these specifically- There's a few episodes of our podcast about these dadus, my favorite being our sixth episode titled Dadu Issues. So definitely check that out.

Speaker 1: [15:45] Yeah. We might need to do an updated one, Dadu Issues Revisited or something like that, uh, just to update, you know, 'cause things have changed in the last couple years since we first released that one,

Speaker 2: [15:55] so.

Speaker 3: [15:55] Exactly. Yeah. It's not a bad idea. Yeah. If you use a HELOC to build a dadu, you can rent it out and then apply the money that you get from the renting towards paying the HELOC payments, right? So this can be a great way for people in the long run to make something work and build wealth if it's done in a, in a smart way.

Speaker 2: [16:16] Mm-hmm.

Speaker 3: [16:16] It can also be used as a backup of sorts. Over the last year, we've all experienced quite an, uh, a lot of unexpected events, such as a pandemic. I don't know, you know. Ah. But there's things outside of that as well, and having access to funds can be really helpful. A HELOC is a great way to be prepared. If you wait until you need it, you may find the bills piling up, because it can take some time, two to four weeks maybe, between applying for the HELOC and closing on it. Again, having it available to you can be beneficial depending on your situation A couple things to keep in mind with a HELOC, if you don't need it, you don't have to access it. Unlike a loan, you don't have to borrow a fixed amount, and your payments are based on what you spend on the line of credit at the end of the day.

Speaker 1: [17:08] Yeah, and I would say you should probably have a HELOC a- and get that set up when you don't need it, because let's say you did lose your job, you might not qualify for that HELOC after you've lost your job. Whereas if you get a home equity line of credit while you have a job, even if you don't use it, you're, you're gonna be all right. You're gonna be able to access those funds after a job loss or a pandemic happens or something crazy in your life takes place and you need to access those funds. Another cool thing about a HELOC, and I confirmed this with a lender, I don't know if every lender looks at it this way, but I know that a lender that I am currently using right now, I asked them, "Hey, if I get a HELOC, and let's say it's, uh, you know, for $200,000, but I haven't accessed any of those funds, I just have that limit available, that credit limit available, does that affect the debt-to-income ratio? Meaning, since I have this credit line, but I haven't accessed any of those funds, is that gonna be a negative on my credit and on what I can afford?" And the answer was, no, it's not going to because you haven't accessed those funds. Once you do access those funds, then some banks will only utilize the amount that you took out. It's a great tool to have kind of as that backup, like Jason said, or as a way to add some additional income. You know, if you can take $200,000 out and build a DADU, and your monthly payment on that would be whatever it is, say $1,200, but the DADU generates $1,800 a month in rent, that's well worth it. That's a great investment for some people. 600 bucks a month, that's, that's awesome. So there's some great ways that you can utilize these HELOCs to give yourself some access to the money that you have already sitting in your home. I hope this was a very insightful podcast episode. I hope it kind of made you think about different ways that you can utilize those, those funds. You don't always have to refinance your home to get out that money. You could get a HELOC, and if you need to use it, you can. If you don't, you don't, you don't really get penalized. Great work today, team. I think we covered a lot. And the listeners, if this, if you're overwhelmed, just reach out to us. We're happy to help. We can give you some referrals like we said earlier. We have people that we trust that, that are good that can definitely assist you. And again, we are not financial advisors, tax advisors, attorneys, any of those things If you have questions in regards to that, ask your advisor, ask your expert. Don't rely on something that you heard on a podcast. We do our best to give you accurate information, but things can change over time. Thank you for joining us on this episode of the Awesome in Seattle podcast. If you wanna put the expertise and experience of the Awesome Nossum Group to you, we help you buy, sell, invest, whatever you wanna do with real estate, we are here to help. So feel free to reach out to us. Our website is awesomenossum.com. Thanks a lot. We'll see you next time.

Speaker 2: [20:06] Bye. Bye, everyone