To HELOC, or not to HELOC?

There's points to be made on both sides. When one year t-bills were at 1%, I took much of our cash, refinanced (no points no closing) to a shorter term, down to 15yrs 5.24%, and used the cash to pay down principle. So for me, there was delta of 4% on that money not earning just 1% as well as the lower rate on the balance. I signed up for the HELOC as a safety net, and never looked back. We have variable income as well, the HELOC floated part of payment on a car purchase for three months, then a year end set of checks hit. We've rebuilt the cash savings since.

Truth is, the HELOC's existence shouldn't hurt. But you need to be careful as to how you use it. I'd rather use that than credit cards if as you suggest, the roof needs replacing. It can be a good tool as part of the big picture, and knowing you from other posts, you're not likely to tap it for an 80 inch plasma TV and theater seating.

JOE

"Will Trice" wrote in message news: snipped-for-privacy@paragondynamics.com...

Hi Will, From all the "experts" I've listened to out there, you don't sound like you're in a situation to need a HELOC. Your emergency fund of 2 yrs is waaaay over the 6 months that the experts tend to recommend. Especially if you are paying the balances on your credit cards every month. However, you shouldn't consider your investments as an emergency fund. You should have your emergency funds in something liquid, like a conventional bank account, or better yet, a money market account that you can write check on. If I were you, I might consider moving 6 months of that retirement into a money market account at your broker. I wouldn't trust in credit as an "emergency fund". If you're paying interest on some credit card or heloc, that is money that could have been invested for your future that is just going out the window. Credit is always a baaaaad idea as an emergency fund. There are a couple of things that you didn't mention so Ill ask. Do you have ADEQUATE life insurance? The experts recommend 10 to 12 times your annual income in life insurance. Term life only. Don't go with whole life, its not that good an investment. And that actually depends on your savings. If you have plenty of savings, you might be able to just "self insure". If you have two yrs of expenses, you're income would need to be pretty big for you to be able to self insure :) Also, you need to examine your lifestyle. How much do you spend each month and on what? That's a rhetorical question. You need to sit down with your wife and figure out if your spending is in control. Its ok to spend if you have the money, but don't be buying things you cant pay for. Cash, and saving cash for a purchase, is always a good way to go, even for cars and houses! If you have no debt, then that should be no problem. Not only does it keep you out of debt, but teaches you discipline in your spending. I don't know if you are members of a church or not, but if you are, tithing is a good idea. Giving should always be something we need to do if we can. God wants us to be givers. You sound like you're pretty financially sound right now. I would personally not consider a HELOC. I can recommend a good course to take. Its called Financial Peace University by Dave Ramsey. I went through it and the ideas do work, as long as you work them. You sound like you're in good shape already, but this course can help you further down the road. Its only about 90 dollars and you can find many churches that present the program. It is an hour or so each week for 13 weeks. You would enjoy it. God bless. Brian

======================================= MODERATOR'S COMMENT: Please trim the post to which you are responding. "Trim" means that except for a FEW lines to add context, the previous post is deleted.

It sounds like there is some mental accounting going on. Once the money is borrowed, it doesn't matter whether you spend it on groceries or a new roof, your house is at risk.

Now I admit that spending HELOC money on groceries would have me thinking about some very serious lifestyle adjustments (like selling the house), the principle remains.

The question is not what HELOC money is being spent on. It is whether you are getting adequately paid (in lower interest rates) for taking the risk of losing the house. Of course the risk of losing the house depends on things like your current and future employment prospects.

-- Doug

As I mentioned in my post, about 30% of our "emergency fund" is in cash, which would be about 7 months of expenses with logical cut backs to our budget. I just can't stand to have any more than that not earning a return, although I understand your concerns about liquidity. We use this cash as a spending buffer, tapping it for big purchases when necessary, then immediately replenishing it.

We don't, really. Credit would be used after our non-retirement assets are depleted. Presumably this would be 2 years or so into a crisis, giving us time to evaluate our situation and decide if we need to sell the house, etc.

Our insurance is adequate with term insurance on both of us, plus a universal policy on my wife.

We know exactly what we spend, this is why I know that our funds are sufficient for 1 - 2 years. As I mentioned before, we don't carry any debt except for our mortgage. That being said, I don't have a problem using debt to make major purchases (house, car) as long as the interest rate is low. For example, I chose to go with a 5%-down, 30-year mortgage because the interest rate was so low (5.125%) even considering PMI. I did the same with my last car purchase with a 3-year, 0.9% loan (since paid off), even though I could have paid cash.

Tithing is not part of our beliefs (this is not to say that we don't give to religious organizations, just that we are not obligated to).

I've only been exposed to Dave Ramsey via opinions here and a few columns I've read when visiting my parents (their paper carries his columns, ours does not). While opinions of Dave here tend to be positive, what little I've read of his has left me unimpressed, but perhaps I've not read enough to form a valid opinion.

Thanks to you and the others for the feedback!

-Will

So you have about 5 months (normal) expenses in something liquid and 7 months expenses invested. What about retirement investments, or is the above all you have? (That's not meant to be demeaning, you have more saved than I do.)

Is there something you envision comming up that may actually exceed your emergency fund (the liquid part?) I don't see why you would set-up a HELOC if you don't see any reason to use it in the near future.

No, this in in addition to our retirement investments.

This is more-or-less my reasoning. I'm cheap, and I don't want to pay the closing costs for something that we can't foresee. On the other hand, my wife argues (correctly) that emergency funding is for things that you didn't foresee in the first place.

-Will

Well, much like with insurance, there is a cost vs. risk balancing act going on. You already have emergency funding in place, your wife's concern seems to be that she doesn't think 1-2 years of emergency funds are enough. (More likely, she is worried that you will be unwilling to tap into the "investment" part of that fund in a genuine emergency. :-)

Let's say the choice is between a $20K HELOC and moving $20K from your investments into something more liquid. How many years would it be before the opportunity loss in your investments would equal the closing cost of the HELOC? Once you have that number, what is the chance that an emergency that equaled a years income + $20K would come up during that time?

Joetaxpayer's response was good, I also recommend the HELOC. When you have an emergency is precisely when you are least likely to have new credit easily available. Sounds like it's too late for the OP, but when you purchase or re-finance, you can often get a HELOC thrown in at no additional closing cost and maybe a $50/year fee.

An argument based on "losing your house" is fallacious because it is strictly emotional appeal. Don't confuse having to move with losing the equity in your house. I doubt that mortgage foreclosure is anywhere near the top of the list of common reasons why people have to move.

A zero-balance HELOC is probably one of the best types of insurance you can get to preserve your house equity, because it can afford you the time to sell in an arm's length transaction instead of being forced to sell in distress. Instead of your equity being a single, highly illiquid lump sum, you can get chunks of it out when necessary to address cash flow problems -- since all financial "emergencies" boil down to cash flow in the end.

Of course you can lose some of the equity in your house whether you move or not, but again I doubt that mortgage foreclosure is a very common reason for it. Your neighbors (especially if they include businesses or the government) are a much bigger risk in that regard.

Plus, you could always use the HELOC to tithe the income from the unrealized gain on your home! ;-)

-Mark Bole

There may be some truth to this statement...

Well, Douglas mentioned that I might have some mental accounting going on. Not only is he probably right, but I think you've given another example of it. Drawing on investments obviously costs me some return, but at the same time, drawing on a HELOC costs me interest. In either case, this would presumably be extremely short term so I'm not sure opportunity cost matters so much?

-Will

According the Dallas Morning News, 21,000 homes have been posted for foreclosure in the DFW area in the first six months of the year.

The article goes on to say that many of them are two or three year old ARMs that are adjusting upward. It doesn't say how many are HELOCs that have gone bad. Not many, I'd guess.

None the less, the risk is more than a "strictly emotional appeal." The reason that HELOCs have low interest rates relative to credit cards is that they lenders have good collateral and people will work very hard to keep from losing their houses.

That said, I would favor an HELOC over credit card debt because you are getting paid well for a relatively small risk. But the risk is real.

-- Doug

If some of your investments are marginable, a margin account can be a source of cash to bridge these income variations. I've used it myself. It's a pretty low cost and easy source of funds. The risk, of course, is that you will be subject to a margin call and have your investments sold at the worst possible time. The risk can be limited by borrowing only 10% or 20% of your investments.

-- Doug

Absolutely it matters! Getting the HELOC (even if you never use it) costs you both the closing costs and whatever income that money would have generated in the future (plus any maintenance fees there may be.) Making some of your investments more liquid will also cost you. Either way a continuing cost is accrued even if you never have any emergency the requires the use of the funds.

As I said, you have to balance the cost vs. the risk. Your wife is willing to pay more to feel safer than you are. To keep her happy, you will either need to open the HELOC or you will have to make more of your current fund liquid. The two of you have to weigh the cost of each option.

That's part of why I keep a HELOC. I've got cash for several months worth, and non-retirement investments which would carry us quite a ways beyond that, but in the event of a crisis, once the cash was spent, I like having the flexibility to choose between the HELOC and liquidating other investments (most of which would have real tax consequences to their liquidation - ie. long-term cap gains).

The thing is that the HELOC is trivial to write a check off of - nice to be able to do that - and then take your time figuring out which taxable investments, if necessary, to liquidate to pay it off - if at all. And way *way* cheaper money than, say, a margin line off of your brokerage account.

Um, if your bank is charging you closing costs and anything more than $50/yr to keep the HELOC open, you're getting ripped off.

Not much. Open the HELOC, borrow nothing but have it available and your total costs are exactly just that $50/yr.

I don't see much downside to it, but maybe I'm missing something that Daniel is seeing here?

He'd have to burn through a lot of other stuff before the "losing your home" argument has any weight. For someone with zero investments outside of his home and retirement account, it might be a concern, but someone who's built up additional assets would need to burn through all those assets, too, before foreclosure and/or bankruptcy became an issue. In fact, having the HELOC may be a very helpful thing to help _keep_ as much of the equity he's got in his house as possible. If he did run out of assets to sell off to pay his mortgage, he'd go into default and potentially have to sell under duress - or foreclosure and have the bank sell it with little incentive to get more than his mortgage balance out of it. The HELOC may provide a cushion and the time to sell the place off in an orderly and, hopefully, more profitable fashion, should it come to this highly unlikely (given his existing savings and apparent history) extreme.

But that isn't the choice presented. The choice, as I understand it, is getting a HELOC compared to moving some assets into a more liquid state.

There you go. Now what are the costs of liquidating enough of the OPs investments to make his wife comfortable? Is it more or less than $50/year?

Not likely. I'm pretty green when it comes to this stuff

I see, I think we were talking past each other. You are arguing in favor of opening the HELOC rather than readjusting his asset mix to have more liquid emergency funds and comparing the costs of both. I was simply saying that opening the HELOC costs basically nothing. It looked to me like you were somehow assigning a high cost to opening up the HELOC, but I think I misread.

Well, I wasn't arguing in favor of the HELOC. I really had no idea how much it would cost to open a HELOC or keep it open. I was simply explaining what costs I would compare to determine what I would do, given the two choices.