As the Fed reacts to the threat of inflation by ratcheting up the prime rate, providers of home equity lines of credit also are reacting in an effort to make those credit lines more attractive to consumers.
But financial planners contacted by National Underwriter say that in general they remain cautious about recommending that a boomer, and particularly a boomer nearing retirement, tap into a home’s equity with a credit line.
The rates of home equity lines of credit track the prime rate. So, boomers who borrow will notice it even if they only make interest payments at first. Later, when principal and interest need to be repaid, they may feel it even more if rates are readjusted upwards.
Michael C. Valdez, a certified financial planner with Triangulum Financial Partners, Tampa, Fla., says he has “some trepidation” with products that have an interest-only component.
Valdez says he does not see these in his practice. He cautions boomers that as a long-term planning tool, there are many unknowns that reflect both the real estate market and their own futures, so care needs to be taken. While it can be a financial planning tool, he notes that “it can be a dangerous play.”
As Marlis Gilbert, a certified financial planner with Gilbert & Cook, Des Moines, Iowa, sees it, “It could be a good idea for someone who is living on the edge. I’m trying to make it so that they are not living on the edge.”
And, as Shannon Wegner, a certified financial planner with Wegner Asset Management, Madison, Wis., explains, since many of his clients are closer to retirement, they have either paid off mortgages or are in the process of paying them off. And, they also would be in the process of paying down lines of credit, he adds.
There are instances when a home equity line of credit can be useful, according to Michael A. Kirsh, a certified financial planner with Kirsh Financial Services, New York.
If it is a choice between a home equity line and credit card debt, the home equity line would at least give you a deduction, he says. In one case, a client wanted to liquidate an IRA to pay for a daughter’s wedding. Instead, he convinced him to use a home equity line of credit and make periodic payments from the IRA so that at least the IRA would remain in place and not be eliminated totally.
But he cautions against excessive debt. Debt without a deduction can be a “fool’s errand.” Planners today are in conflict with Madison Avenue, he says, with the need to save being pitted against the need to consume.
Nan Sabel, a certified financial planner with the Women’s Financial Network, Bedford, Mass., says that in certain instances, a home equity line can be advantageous.
For instance, one couple she works with has a home that is paid off and has $800,000 in equity. Rather than take out a loan for two cars that would not be deductible, she recommended a home equity line.
But for those using a home equity line for a car or other short-term asset, Sabel says the boomer should not be paying off the loan over 10 years or 20 years. Rather, an effort should be made to pay it off more quickly, she explains.
Home equity lines usually have no closing costs associated with them unless the property is in a trust, she says. And, even then, at least in Massachusetts, the fee is only about $150, Sabel continues. The transaction usually can be completed in about 2 weeks, she adds.
Where she is more cautious about a HELOC is when it is used to pay off credit card debt. If it is a student loan, that is one thing, Sabel says, but if it is credit card debt, then the behavior needs to be addressed so that the boomer doesn’t build up more credit card debt.
For clients who want or need to tap into equity, home equity lines of credit are being redesigned to make the product more attractive to consumers, according to Mike Fratantoni, senior director, single family research and economics with the Mortgage Bankers Association, Washington, D.C.
Some of these instruments are being designed so that a borrower can move from a variable to a fixed rate, he says.
Since home equity lines of credit are tied to short-term rates, which are edging up, and long-term fixed rates are tied to long-term rates, it might be more advantageous to look at a long-term fixed loan, Fratantoni explains.
So, for example, if you have $50,000 in a home equity loan, you might move it to a 10-year or 20-year fixed rate loan that is a second mortgage, he adds.
Gibran Nicholas, president of Nicholas & Co., Ann Arbor, Mich., which offers mortgage planning strategies, concurs. Home equity lines of credit are plus or minus 1% of the prime rate, he says. And better rates for home equity loans do not start until loans total $100,000 to $150,000, he adds.
Both options are still not as attractive as a first mortgage, he continues. “There is a lot of interest now the way that the Fed is going,” he says. The prime rate is now at 6.75% and “with more rate hikes on the horizon, people are getting antsy.”
But baby boomers are a very affluent generation and different from previous generations, Nicholas continues. Their financial needs are different and they will need to be offered new options, he adds.
There are a number of ways to access money using first or second mortgages, he adds. For example, if you had $200,000 left on a mortgage on a $500,000 house and another $50,000 on a variable line of credit, and needed another $50,000, then you could do one of several things, Nicholas says.
One option would be to take a $100,000 second mortgage and pay off the $50,000 variable rate line of credit.
Another option would be to take out a $300,000 first mortgage and pay off the $200,000, the $50,000 variable line of credit and then have $50,000 in funds at the borrower’s discretion, he adds.
Many advisors urge approaching this kind of debt with a good deal of caution
While a home equity line of credit can be a useful financial planning tool, some advisors think that “it can be a dangerous play.”