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Last year I bought a home on a 80/10/10 program. The plan was that I would pay off the HELOC loan in 2 years at a much lower cost than PMI would be on a 90% traditional mortgage and I saved .5% on my 30 year fixed interest rate.
The facts:
- Pay-off Balance: $24,811
- Interest rate: Prime + 1.99%
- Cash on hand: $36,000
- Monthly expenses: $3,000
Typically I like to keep 1 year of cash on hand, but I had more risk of extended unemployment 2 years ago than I do today. I'm trying to get comfortable with the idea of keeping just 6 mo of funds now. Is it is better to pay off the full balance now, leaving only 4 mo of cash in the bank, or to leave $6,000 on the HELOC and 6 mo in the bank? With the latter, the HELOC will be paid off next March. Also, its just me, no kids or spouse to provide for.
I asked my PFA who says that I can consider my HELOC as my liquid cash reserves and basically keep $0 in the bank. I get the logic, but that makes me nervous for 3 reasons:
The bank randomly appraises homes and if a home appraises lower than the current limit, the account is frozen.
If I lose my job, I'm borrowing money at a variable rate to cover basic bills. Cash reserves, while they do not earn anything, have no strings attached.
HELOC's can be frozen for a number of other reasons that are outside of my control meaning that it might not be available if/when I need it.
I have no problems using the HELOC to pay for big ticket items such as the roof, HVAC, siding, etc...all of which I will do in the next 8 years. But this is done with an understanding of the interest rate and job stability and an amortization schedule I setup in advance.
I'm a bit nervous overall about my PFA's recommendation, but it seems to be a very common viewpoint in the financial industry today. Not sure how I feel about that...
This HELOC will not be closed. I can carry a zero balance and pay the $75 maintenance fee to keep it open. I'm being careful about this since there is a $475 fee to close before 60 months has passed.
I asked my PFA who says that I can consider my HELOC as my liquid cash reserves and basically keep $0 in the bank. I get the logic, but that makes me nervous for 3 reason
I suggest the above. Pay down to $0 balance but keep it open.
Not having a HELOC should not make you nervous!
Most HELOC's don't have a maintenance fee so once your 60 months is up - move to another financial institution if possible.
I think the overall plan is a bad, bad idea. I agree with having a HELOC, everyone should have one, but not having any available cash in the bank is always a bad idea. Having 6 months in "cash" in the bank is prudent, your HELOC can be another 6 months. Unless you are independently wealthy, no job/income is secure enough not to have at least a year of liquidity. That doesn't mean you have to have a year of expenses sitting in a low interest savings account, but having a year (or more) available in savings, CD's, HELOC is necessary. After the last market crash, even having a year's worth isn't enough of a safety net for me.
Last year I bought a home on a 80/10/10 program. The plan was that I would pay off the HELOC loan in 2 years at a much lower cost than PMI would be on a 90% traditional mortgage and I saved .5% on my 30 year fixed interest rate.
The facts:
- Pay-off Balance: $24,811
- Interest rate: Prime + 1.99%
- Cash on hand: $36,000
- Monthly expenses: $3,000
Typically I like to keep 1 year of cash on hand, but I had more risk of extended unemployment 2 years ago than I do today. I'm trying to get comfortable with the idea of keeping just 6 mo of funds now. Is it is better to pay off the full balance now, leaving only 4 mo of cash in the bank, or to leave $6,000 on the HELOC and 6 mo in the bank? With the latter, the HELOC will be paid off next March. Also, its just me, no kids or spouse to provide for.
I asked my PFA who says that I can consider my HELOC as my liquid cash reserves and basically keep $0 in the bank. I get the logic, but that makes me nervous for 3 reasons:
The bank randomly appraises homes and if a home appraises lower than the current limit, the account is frozen.
If I lose my job, I'm borrowing money at a variable rate to cover basic bills. Cash reserves, while they do not earn anything, have no strings attached.
HELOC's can be frozen for a number of other reasons that are outside of my control meaning that it might not be available if/when I need it.
I have no problems using the HELOC to pay for big ticket items such as the roof, HVAC, siding, etc...all of which I will do in the next 8 years. But this is done with an understanding of the interest rate and job stability and an amortization schedule I setup in advance.
I'm a bit nervous overall about my PFA's recommendation, but it seems to be a very common viewpoint in the financial industry today. Not sure how I feel about that...
$6,000 on HELOC and keep 6 months emergency fund. The issue is, as you say, if the house goes down in value they might close the HELOC and then you'd be in a tough spot.
What about the "overall plan" do you find to be a bad, bad idea? I'm not sure I understand what you mean by that? the 80/10/10 mortgage program in general or what?
I agree with having a HELOC, everyone should have one
Slightly off topic: I'm curious, what percentage of the home value do you think is prudent to have on such a HELOC, which I assume would be for quick access to liquid funds? Personally I wouldn't want to go higher than 20%. That's with a scenario in which a homeowner already has a very large percentage of equity already in the home.
Last edited by Ninotchka P; 03-10-2015 at 05:21 PM..
Slightly off topic: I'm curious, what percentage of the home value do you think is prudent to have on such a HELOC, which I assume would be for quick access to liquid funds? Personally I wouldn't want to go higher than 20%. That's with a scenario in which a homeowner already has a very large percentage of equity already in the home.
I'd be interested to hear the answer too. I did this as a second mortgage and there was a rule that I could not borrow more than 10% of the homes value on the 2nd, but I was borrowing 80% on the first. I'm not sure if those rules change if there is less than 80% on the first or if the HELOC is the first. I know I've heard of people borrowing much higher on interest only mortgages, but I am not sure if that's legal any longer.
Your point 2 doesn't really matter; if you don't pay off the HELOC you're borrowing at a variable rate regardless of whether you lose your job. So the question to worry about is whether you'll lose your job and the HELOC will be closed down at the same time. I'd rate that as pretty unlikely (I had a HELOC through the last crash, they never even reduced the line amount) though obviously possible. I'd pay it off, or if you can avoid the maintenance fee by leaving money on it, do that.
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