markbarbieriJuly 26, 2009

We finished paying off our house this weekend and are now debt free. A few people have suggested opening a HELOC to increase our liquidity. Honestly, I'm pretty comfortable with our liquidity right now, but in these times I guess you can't be too careful.

What are the pros and cons of getting a HELOC when I think that there is a very small chance of ever tapping into it?

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1) available if you need it quickly

1) You might have to pay fees, both initial and annual, on the loan

    Bookmark   July 26, 2009 at 8:53PM
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Do you have an emergency fund? If you have a major auto repair, need to replace furnace, suffer substantial illness (possibly including being off work for a period), etc., do you have a cushion of funds that you can tap into in order to keep operational (without sweating blood)?

It may be easier to initiate one when things are going smoothly than when your ship of state may be enduring choppy seas in future.

Do you have family members who may have need of funds ... or adult kids who may come back home (boomerang kid), etc.

How secure is your employment situation? If you should be laid off, especially if it appears to be pretty well permanently, no doubt a lender will be much less inclined to open such a Line of Credit than now when things are going smoothly. Should such happen even with a HELOC in place, when they learn of your loss of employment, they may be unwilling to let you use it, but there's a much slimmer possibility of that than if you didn't have it and went in to try to set one up at that time.

As jkom51 says, a major deterrent would be if there's a fee to initiate such a Line of Credit, or an inactivity fee once it's established.

Although as a personal financial advisor I've recommended to many that they have several months' worth of employment income available for short term use in case of emergency, I don't like earning interest, as usually the principal can't grow, the only "growth", interest that it will provide is now, the interest is taxed, and in Canada at top rate, while dividends on Canadian stocks used to carry a much lower tax liability level, which was reduced even further recently.

So I often have only a small amount of near-cash readily available, and have a couple of credit cards (one with minimal credit limit that I use for online purchases, etc.) that I can use when an emergency crops up. Then I draw on my line of credit (that I've held for about ten years, with no initiation fee and no inactivity fee, that lies there most of the time unused) to pay off the credit card balance in full just prior to the due date, to avoid their high interest rates.

Then I try to pay down the line of credit rather quickly, especially as most emergencies won't be related to a tax deductible issue.

I will only use a credit card or other loan to purchase consumer goods in very unusual circumstance ... but I may choose to borrow to invest in a capital good, especially of a kind that I expect to grow or make money for me on an ongoing basis, especially if there's a prospect that the rate may grow, over time.

If you have a mind to, you may use the L O C to purchase capital goods, such as stocks.

I've said for a time that I could borrow for about 6% (three or four years ago) and just about break even, so it makes it more attractive now that interest rate is recently under 3%.

As my purchase of investment with the intention of making profit makes the interest paid deductible, that reduces my 6% to about 4.5% after-tax cost, and if I use the loan to purchase shares of a fairly solid Canadian bank, or utility, e.g. pipeline, paying about 3% dividend, which, after tax, leaves about 2.5% in my hand, that reduces the net cost of the loan to about 2%.

If you put $10,000. into the bank 15 years ago, they'd pay you rent on the money in the meantime, and if you went to collect it now, they'd give you exactly $10,000. ... that'll buy much fewer goods now than it would have 15 years ago - you got burned by inflation.

If I'd borrowed that $10,000., and paid only rent on the money throughout, and went in to pay off the loan now, I'd pay the bank exactly the $10,000. that I'd borrowed ... that'd buy less now ... so I gained due to inflation.

When I sold mutual funds for a brief period back in '84, some folks, especially seniors, told me gleefully how they'd earned 19% on Canada Savings Bonds back in '81.

I said that the amount added to their bank book looked nice ... but that they had to pay tax at top rate on that interest income, which at 25% would take their after-tax return down to just under 15% ...

... and did they know what the rate of inflation was back in '81? Most didn't ... how about 12%?

They found it hard to believe that they'd only really earned about 2 - 3% on their invested asset, earning interest, at that time.

Good wishes for making a decision that you'll be pleased with, over 1, 2 and 3 years ... and up to 10 or so, if you have a mind to.

ole joyful

    Bookmark   July 27, 2009 at 5:36AM
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