When evaluating reasons for the housing crash in 2008, one of the subjects that often comes up in the discussion is homeowner’s use of home equity lines of credit. When consumers use the equity lines of credit as ATM’s to justify overspending and living beyond their means, the spending is not sustainable. Homes can be used as a source of building wealth, which many Americans depend on, when it comes to retirement planning. Maxing out the equity can create a problem for both homeowners and banks.
Today, there has been a rapid increase in banks extending equity lines of credit. This will impact the market, as well as consumer’s access to cash. Equity lines of credit are based on the value of the home, subtracting existing mortgages. If there is a balance that can serve as an equity line. This provides consumers with access to cash based on the value of their home.
Advantages of Home Equity Lines
The biggest advantage to an equity line of credit is that there is a built in emergency fund in the event the homeowner needs cash. An equity line can be put into place at any time. Interest charges only accrue if a cash advance is made on the line of credit. This provides homeowners with a cushion.
Homeowners use lines of credit for a variety of different expenditures. Some use the line to pay off credit cards. This can be dangerous because if spending habits are not changed, the homeowner can run the balances on the credit cards back up and be in twice the predicament they were before.
Homeowners also use home equity lines of credit for home improvements. This can promote economic growth and upgrade a home, building additional equity. If the HVAC system needs replacing or a kitchen renovated a homeowner can tap into their line of credit.
The revolving line of credit can be accessed, paid down, and accessed again. Since lines of credit are generally available for 10 years or more, having a line in place can provide a safety net for homeowners with adequate equity.
Disadvantages of Home Equity Lines
The biggest drawback to a home equity line is that it comes with a variable rate of interest. While the interest rate is still significantly lower than credit cards, lines should be utilized with caution. Experts anticipate that interest rates will begin to rise over the next few years. When consumers are making interest only payments, an increase from 3% to 5% is nearly doubling the interest on the line of credit.
Typically lines of credit are associated with the prime rate and will adjust accordingly, if the FED begins raising those rates. This could potentially leave homeowners with thousands of dollars in variable rate balances. One of the causes of high foreclosure rates over the past few years was rising variable rate loans.
Home Equity Lines of Credit have their place in the world of lending. Yet those very resources can turn into obstacles if not used correctly. It is important to use wisdom when establishing and accessing the equity in real estate property.
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