Let’s take a look at what a margin is and why margins matter in a HELOC (Home Equity Line of Credit). For the purpose of this post on April 20th, 2018, we’ll be using the HELOC page found here.
HELOC margins range
What we see on the HELOC page is that margins can range quite a bit. In some cases, margins are as low as -1.25. Other margins show as high as +1.00. What does this mean when it comes to a HELOC and why is it important?
A real-world HELOC example
Let’s take a look at an analysis for a client that may be interested in obtaining a $100,000 line of credit. Here it is:
In this particular analysis, we will be comparing a “High Margin” and “Lower Margin” line of credit. In both cases, the Prime Rate is the same because it is not set by the bank. The margin, on the other hand, is set by the bank offering the line of credit. This is where you see a range of options.
The High Margin HELOC
The High Margin HELOC shows a margin of 0.50 percent. When we add this number to the prime rate, we can see that our effective interest rate is 5.25%. This interest rate will be charged until the prime rate moves up or down. Any movement in the prime rate will simply move the Interest Rate by the same amount.
In this specific case, a client borrowing $100,000 at a 5.25% rate will need to pay $437.50 each month.
Lower Margin HELOC
When we compare the lower margin line of credit, with a margin of -1.25%, we see that the same client may end up paying just $291.67 per month. This lower margin results in a savings of nearly $146.00 each month.
2018 Tax Rules may make this more important
Historically, any interest associated with a line of credit could be written off against income. Said another way, a homeowner who obtained a line of credit wasn’t “really” paying the interest rate they were given. This is because they were able to deduct the interest payments from their earned income and receive a tax refund as a result.
The new tax laws starting in 2018 have changed the laws for HELOCs. Now, there are many instances where the interest paid towards a HELOC may no longer be tax deductible. Due to this, it is more important than ever to consider savings that may be available from a HELOC with a lower margin.
HELOCs for Wealth Management Clients
Next, let’s examine a $250,000 Home Equity Line of Credit.
The same margins from above show that a savings of $364.58 is possible between a high margin HELOC and lower margin HELOC.
Cost and Shopping HELOCs
Home Equity Lines of Credit are easy to obtain and the costs to obtain them are either $0 or less than a few hundred dollars. All else equal, it is important to understand how shopping the margins between HELOCs can have a substantial impact on monthly free cash flow.
If you’d like to evaluate lines of credit in the Philadelphia area, go here.