A home equity line of credit (“HELOC") can be an excellent financing tool, if it is used properly. A HELOC is basically a credit card secured by a mortgage or deed of trust on your property. You only pay interest on the amounts you borrow on the HELOC. If you don’t use the line of credit, you don’t have any monthly payments to make. You can access the HELOC by writing checks provided by the lender. In most cases, it will be a second lien on your property.
HELOCs are being advertised on television as a way to consolidate debt, but can be used much more effectively by investors. When you need cash in a hurry for a short period of time, a HELOC can be very useful. For example, if a seller tells you, “give me $75,000 cash on Friday and I’ll sell you my house for a song," you need to act in a hurry. Another example of cash in a hurry is a foreclosure auction, which, in many states, requires payment at the end of the day of the auction. When you need cash in a hurry, there’s no time to go to the bank.
While the HELOC may be a high interest rate loan, it is a temporary financing source, which can be repaid when you refinance the property. Do not use your HELOC as a down payment or any other long–term financing source – it will generally get you into financial trouble. If you don’t pay the HELOC, you can lose your home!
Some institutional lenders will not lend you the balance if you borrowed the funds for the down payment. However, smaller commercial banks that “portfolio" loans have more flexibility and may allow you to use HELOC money as a down payment. Once again, I must caution you about using borrowed money in this manner – only do it if the deal is a steal and you can pay off the HELOC money within a few months. DEDUCTING HELOC INTEREST
There are limits on the deductions you can take on your personal tax return for interest paid on your HELOC. Generally speaking, you can only deduct that portion of interest on debt that does not exceed the value of your home and is less than $100,000. But, if you do your real estate investments as a corporate entity, you can always loan the money to that entity and have the entity take the deduction as a business interest expense. This transaction must, of course, be reported on your personal return, and must be an “arms–length" transaction (i.e., documented in writing and within the realm of a normal business transaction). Consult with your tax advisor before proceeding with this strategy. USING CREDIT CARDS
You may already have more available credit than you realize. Credit cards and other existing revolving debt accounts can be quite useful in real estate investing. Most major credit cards allow you to take cash advances or write checks to borrow on the account. The transaction fees and interest rates are fairly high, but you can access this money on 24 hours notice. Also, since credit card loans are unsecured, there are no other loan costs normally associated with a real estate transaction, such as title insurance, appraisals, pest inspections, surveys, etc.
Often, you will be better off paying 18% interest or more on a credit line for three to six months than paying 9% interest on institutional loans, which have up front costs that would take you years to recoup. Again, use credit cards carefully and only as a temporary solution if the deal calls for it.
The home equity line of credit of an individual is considered to be deductible as a second mortgage for many people, but there are a number of considerations that need to be adhered to before the individual can actually deduct their interest on their taxes. A home equity line of credit can be used as an itemized deduction when the individual is legally liable to pay the interest on the home equity line of credit, the individual pays the interest during the course of the tax year for which they are filing their taxes, the debt is secured with one's home and the interest that is deducted does not exceed the specified limitations as set forth by the Internal Revenue Service. In addition, it is important to note that there are limitations that are put on the amount of interest that can be deducted as a second mortgage on the individual's taxes.
It is important to note that there is a difference between a home equity line of credit and a home equity loan and this is very important since there are consequences to each type of loan. These differences are important to note especially when considering the taxes of an individual and how much interest can be deducted on the individual's taxes. Home equity loans have a number of specified characteristics that differ from the home equity lines of credit that individuals can receive and this will come into play when the individual files their taxes. A home equity loan has a fixed interest rate which does not change over time, as well as regular monthly payments that have been timed and sized to be paid off over the defined time limit, as established by the financial institution that gave the individual the home equity loan.
A home equity line of credit, using the anagram HELOC, has different aspects. This line of credit does not have a fixed interest rate. Instead, the HELOC has an adjustable rate of interest. The interest rate is typically tethered to the changes in the prime rate of the line of credit. In response, the prime rate of the line of credit is tethered to changes that have occurred within the targeted federal funds rates.
The HELOC is considered by the IRS to be a second mortgage on a home. Any mortgage that is placed on a home that is not the primary mortgage or loan taken out in order to purchase, build or reconstruct the home is considered to be a second mortgage. As a result, the HELOC is considered to be a second mortgage and thus deductible as a second mortgage if the individuals are able to meet the criteria necessary and set forth by the IRS. By definition, it is possible for the HELOC to be considered as a second mortgage and thus the interest is deductible on the person's taxes. Limitations that exist include that the individual cannot deduct more than $100,000 in interest per year. If a couple is married but filing separately, the individuals, on their own, may not deduct more than $50,000 each.
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