For many years now, I have been promoting one of the greatest and most invaluable (but underappreciated) financial planning tools—the home equity credit line (HECL). An HECL is an agreed-upon balance that you can borrow from at your own choosing on a portion of your home’s equity. If you borrow against the credit line, then you immediately begin to pay interest, but if you do not, then you do not pay anything.
The best part of this financial planning tool is that there is no cost to obtain an HECL unless you sell your house within two or three years of establishing the credit line. Consider, for example, that you own a home that is worth $400,000 and has a $100,000 first mortgage. If you take 80 percent of the home value ($320,000) and then subtract the first mortgage of $100,000, then the net is a potential HECL of $220,000. In this scenario, most banks would offer a $220,000 HECL with no cost upfront, and you would pay interest only if you actually borrowed money. The minute you pay any or all of the balance, the interest immediately stops being charged on the amount that has been paid off.
Think about the strength of this financial planning tool. Say need to buy a new car. You can purchase the car with cash, with an auto loan, or with an HECL. Say you are planning on performing a home improvement—you can pay cash or use an HECL. What if you are going to move to another home but you have not yet sold your current home? Do you pay cash for your new home by selling your investments, thus creating a tax liability, or do you use your HECL to transfer values from your current home to your new home? As soon as your current home sells, the HECL is paid off and closed. These examples illustrate some of the ways HECLs can be used to meet financial needs.
The most common refrain we hear is, “I do not need to borrow money, so why would I establish an HECL?” The reason you would establish an HECL without an immediate need for it is because you do not know what the future holds, and an HECL is a free financial tool worth having at your disposal. Another common refrain is, “I do not use debt and try to keep debt-free.” Yes, it is important to strive to be debt-free, but if an HECL can serve as a significant cash resource until assets can be liquidated, then it serves as a great tool.
Take this common scenario: A client needs $50,000 to buy a car. The majority of his or her assets is in pre-tax retirement accounts, which, if they are all liquidated in 2018, will cost the client $20,000 in tax liability. If half of the assets are liquidated in 2018 and the other half in 2019, using the HECL to cover the gap, then the tax liability is only $17,000, plus $500 in interest. Would it not be wise to use the HECL tool to save $2,500?
Some clients think it is a hassle to go through all the paperwork to establish an HECL, but life is full of complications. I wish there was an easier way to obtain an HECL, but the banking world has grown far more restrictive since the housing crisis of 2008. Prudent stewardship requires embracing some pain.
The hope is that you will never have to use your HECL, which has a 10-year lifecycle. Every 10 years, the banks force you to re-establish your home equity line of credit. If you have an outstanding balance at the end of 10 years and choose not re-establish a new HECL, then you have a five-year amortized payment plan to pay off the balance.
Nonetheless, given that an HECL costs nothing to establish or keep unless borrowed against, an HECL is an invaluable tool in the personal financial planning tool belt. It is important not to forget the old adage, “The worst time to ask a bank for a loan is when you need one.” It is unfortunate that this statement is so true. If you lose your job and need cash, then the HECL will be invaluable as a resource, but if you ask a bank for a loan after your job loss, then they most likely will decline your request. If you are selling your house and request from a bank the necessary funds to buy a new home before your own house sells, then the answer from a bank will likely be “no.” Now is the time to establish your HECL as a resource that you can tap into for future borrowing needs.
The Financial Consulate does not take commissions or referral fees, but instead possesses established relationships with banks to help you get the best deal possible on an HECL. In addition, we can intercede if you, our client, feels that you are not receiving adequate attention from a bank.
Call your Financial Consulate relationship manager at 410-823-7283 for a referral if you have not yet established your HECL.