You may have heard recently that “tappable” home equity has reached an all-time high, thanks to rapidly appreciating home prices and conservative borrowing on behalf of existing homeowners.
If you haven’t, know that some 42 million homeowners have around $5.4 trillion in equity at their disposal, assuming a maximum 80% loan-to-value ratio (LTV), this according to Black Knight’s latest Mortgage Monitor report.
Put another way, 80% of all those with a mortgage have the ability to tap into their home equity, either via a home equity line of credit (HELOC) or a traditional cash-out refinance.
But because mortgage interest is no longer deductible on HELOCs, and current mortgage rates are so low, borrowers may not be interested in doing either.
Ironically, this will just drive up that amount of tappable equity, as borrowers continue to pay down their mortgages. And some may even choose to pay their mortgages down early because of the diminished tax break for mortgage interest in general (thanks to that higher standard deduction).
Instead of a HELOC, Why Not Just Use a Credit Card?
I know, I know, this sounds crazy and irresponsible. But bear with me here. I was pondering this the other day when thinking about doing some relatively minor, yet still expensive (funny how that works), home improvements.
Let’s pretend that you want to remodel a bathroom and the price tag will be somewhere in the neighborhood of $6,000.
Instead of opening a HELOC with your bank, paying closing costs, going through the approval process, and winding up with a second mortgage, you could just open a credit card in a few minutes instead.
But not just any old credit card. It would need to be one that offers 0% APR for an extended period of time, which would allow you to borrow for free.
This isn’t hard to do, nor are the offers limited these days. There are plenty of credit cards that offer 0% APR on purchases for as long as 18 months or longer.
In other words, as long as you make just the minimum payment each month, you won’t pay any interest for a full year and a half.
Of course, you’ll want to pay down the full balance over that time to avoid carrying the debt over once the interest rate adjusts much higher. That’s the trap with these offers.
Let’s pretend that you amortize the $6,000 over that period and pay roughly $333 per month to extinguish the renovation costs over 18 months.
While $333 per month might sound pricey, that’s all you’d have to pay. Nothing extra for borrowing that money and paying it back over a year and a half. It would probably feel a lot better than parting with the full $6,000 in one shot.
Additionally, there are no closing costs, annual fees, early closure fees, underwriting fees, or anything else, so long as you pay off the debt before the 0% APR period comes to an end.
Can’t Avoid Interest with the HELOC, and You Might Pay Fees Too
With the HELOC, which might be set at a rate of 5% or higher, you’ll wind up paying interest each month and likely some fees to open the thing. And maybe even some fees to close the thing, assuming you don’t keep it open long enough to satisfy the bank’s requirements.
That could amount to $500-$1,000 or more in costs using our simple example from above. While it might not seem like a lot of money, as a percentage of your costs, it’s quite high.
We’re talking 8-16% or higher in terms of cost of borrowing to do that renovation. Then there are the intangibles, like the ability to let your debt ride, thanks to HELOCs having an interest-only draw period.
Or the temptation to take out more money to do other things, or perhaps just getting sloppy with costs as the money is readily available.
This can happen with the 0% APR credit card too, but knowing the window to borrow cheaply is short and defined, it might motivate you to pay it all off in a timely fashion and stay on budget.
The takeaway here is that for relatively minor jobs, you might be able to get away with using an interest-free credit card as opposed to a HELOC.
A lot of HELOCs have lines as low as $10,000, but why bother if you can get a credit card with a similar or higher credit limit, which charges you nothing to open it and no interest for a fairly long period of time?
The only time the HELOC would probably be favored would be if you were truly spending outside your means, and needed a prolonged period of time to pay back the debt.
Or if the job was a big one; a simple credit card likely wouldn’t be sufficient to cover the costs.
The other downside to the credit card would be the inability to pay cash or write a check, assuming the contractor didn’t accept plastic as a form a payment.
So there are limitations, and not necessarily a one-size-fits-all solution, but I do believe credit cards are overlooked when it comes to small to medium home renovations.
Making matters worse for HELOCs is the fact that they’re slated to get more expensive this year as the Fed increases rates, thus driving up the prime rate consumers pay.