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If you own a home and you’re looking for some emergency funding, you may be running out of opportunities.
Home equity lines of credit allow you to borrow against the equity you’ve accumulated in your home, be it for a surprise cash need or a home renovation.
HELOCs are a revolving line of credit, meaning once you’ve opened it, you can use it in a pinch — say, you lose your job —repay it later and keep the line open.
Some banks are becoming nervous about extending HELOCs amid the economic uncertainty around the coronavirus pandemic. In April, Wells Fargo and JPMorgan Chase temporarily halted applications for these lines of credit.
“I think the banks are clearly in an anticipatory move, saying ‘Hey, we’re going to get a flood of applications,'” said Doug Boneparth, certified financial planner and president of Bone Fide Wealth in New York.
“If you have this massive demand for setting up lines of credit, you as the financial officer of a company will feel cautious about opening the books to anyone and everyone – it’s likely too much risk,” he said. “The bank is feeling the uncertainty in the same way.”
Even if you were to obtain a HELOC, there’s still no guarantee that a bank won’t freeze the line in the future — or that it could reduce the amount of credit available to you, said Greg McBride, chief financial analyst at Bankrate.com.
That means now just might be the best time to shop for a HELOC, so that you at least have the option available.
A hierarchy of emergency funds
A robust emergency fund – one that can cover at least three to six months of expenses – should be where you turn in a financial shock, including unemployment or surprise costs.
Beyond that, a taxable brokerage account, in which you sell some of your fixed income holdings, might come in second place in a pinch, said Boneparth.
A HELOC would come in third in the list of rainy-day options, he said.
Right now, the average interest rate on this type of credit is 4.86%, according to Bankrate.com. Meanwhile, credit cards are charging an average rate of 16.32%.
HELOCs also enjoy some limited tax benefits, but only if you’re using it for buying, building or substantially improving the dwelling that’s securing the loan.
You can’t claim a deduction for HELOC interest if you’re using the line of credit to get you through a spate of unemployment or for consolidating debt.
Think before you apply
Interest on a HELOC is typically tax-deductible only if you use the money to finance home improvements — one reason a home equity line is most commonly used for this purpose.
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If you’re adding to your arsenal of emergency funding, it might not hurt to apply for a HELOC and leave it untapped until you need it. Just be aware of a few things before you commit.
• Know the terms of drawing: HELOCs generally have a stated draw period in which you can borrow against your home equity. After the draw period ends, you begin repaying the loan.
Some lenders require HELOC applicants to take a minimum draw shortly after the line is opened – and this might not jibe with your plans.
“If you set it up as an emergency line of credit, stay away from offers that require a minimum draw at closing,” said McBride at Bankrate.com.
• Watch that interest: Before you open the line of credit, think about how you’ll repay what you borrow in the future.
Is the interest on your HELOC fixed or variable? Are you expected to repay it on a monthly basis, or are you making a balloon payment — a large sum at a later date? These are a few things to consider as you weigh offers.
• Keep an eye out for fees: Getting a HELOC isn’t all that different from getting a regular mortgage. Prepare for expenses tied to getting your home appraised, as well as application fees, closing fees and other costs.
“You’ll have processing times, front-end fees, the potential for an appraisal and then a three-day rescission period before you can get your money,” said McBride.