Should We Close The Home Equity Line of Credit Early?

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Mrs. PoP had to tell Mr. PoP how to spell this!

Our HELOC (home equity line of credit) is a line of credit that was extended against the value of our investment duplex (which didn’t have any other mortgage liens against it). Having dumped about almost $60K in cash into the duplex over 6 months between buying it and fixing it up, we were looking to have access to some of that capital should the right real estate deal present itself. And the HELOC was the right balance of cost and benefit to provide us with access to that capital when we needed it.

 

So Here’s The Deal

After extending the full $38K HELOC to help us buy our residential canal lot in November 2011, we paid the entire balance off a few months ago. (We were quite excited that the HELOC was dead!) In a couple of months, we’ll hit the 2nd year anniversary of opening the HELOC, and we’re evaluating if it’s worth it to close the HELOC early and pay the early termination fee or to keep it open and continue to pay the ongoing costs associated with it that we pay on the anniversary of opening it each year.

 

Our HELOC Terms…

  • 10-year interest only at a variable rate (currently 5.99%)
  • Minimum Payment: Interest in full every month, no penalty ever to pay toward principal
  • Minimum Balance: $0 – no minimum balance requirement
  • Cost to Open: ~$400
  • Cost to Close: $500 if close within the first 4 years as an early termination fee
  • Ongoing Costs: ~$310 in yearly flood insurance premiums

 

Why Is Flood Insurance A HELOC Cost?

Our duplex is in a neighborhood that was recently reclassified by FEMA as a 100-year storm surge flood zone. Just a couple blocks away is an area that’s basically the same but was not reclassified. Basically, our duplex is in a very borderline in terms of its 100-year flood potential, and before the bank required us to carry a FEMA flood policy for the HELOC we did not. It’s unlikely that we will keep the flood policy in place after the HELOC is closed, which is why we look at it as a cost of the HELOC financing.

The way we see it, now that the HELOC balance is at $0, we have 3 options.

Option 1 – Close the HELOC Now

  • Costs $500 out of pocket now

Option 2 – Close the HELOC right at the 4 year mark

  • Costs $310 out of pocket this summer, and $310 out of pocket next summer

Option 3 – Keep the HELOC open indefinitely

  • Costs ~$310 for the next 8 summers

 

We’re Leaning Toward Option 2

Even though it’s going to cost us $120 more over the next two years, we’re leaning toward Option 2 right now, and here’s why the big reason why.

We’re probably going to be cash poor pretty soon.

We recently mapped it out, and so long as the poop doesn’t hit the fan, we’ll have just over $50K in cash available to pay Mr. PoP’s parents back IN FULL on August 1 of this year, which we’d like to do. [For new readers – the $50K is a personal loan that Mr. PoP’s parents loaned us in order to buy that duplex in the first place. It’s the last piece of debt besides our mortgage on the PoP balance sheet.]

We want to keep the bookkeeping on this loan as simple as possible (since it’s family!) and paying in full on the 3rd anniversary of the loan is a good way to do that. Technically the loan isn’t due until August 2015, but we’re pretty eager to get it off the books even if it means leaving us with what we consider a VERY small cash buffer (< $5K).

On a typical month, we throw off about $3K in cash savings, so while we’re rebuilding our cash stash, the HELOC would be a very nice safety net in case we have something big come up (like the duplex’s other AC unit) that we need to address.

 

Why Not The Other Options?

Option 1 – Seems penny wise and pound foolish. It’ll save us some money, but it feels like we’re taking on enough risk in other areas that I’m not nuts about that idea.

Option 3 – Seems a bit unnecessary. Unless we find some investments that we think are going to net us much better returns than the interest expenses, it seems like we’re paying a pretty high premium to have that capital available. Not to mention that as interest rates rise (which I don’t think the Fed can postpone forever) the variable rate of our HELOC will rise along with it.

 

What do you guys think? Are there other options that we’re not seeing? What would you do if you were in our shoes?

30 comments to Should We Close The Home Equity Line of Credit Early?

  • Lucas

    I agree that option 2 sounds the best right now. looks like RE prices are going up again too fast, and now is the time to build some investment cash to look for opportunities down the road. I know RE is local, so you know your market better than I would. My area though is completely out of whack again already with price to earnings potential. So i am doing very similar thing to you – paying off personal loan to family this year that we used to buy our house, and then building cash for future investments outside of my current area i live.

    • It’s been tough to find value purchases in residential real estate here for at least a year. Sounds like we’re in a similar boat.

  • If you’re intent on paying off the $50K this summer, and you don’t have other liquid reserves, then I would agree that Option #2 is probably best. Do you have non-retirement investments that could be used in the case of an emergency? If so, those might be an alternative. But I do agree that the extra $120 is not a reason to put yourselves at risk of not having cash in an emergency.
    Matt Becker recently posted..Changing One Habit at a TimeMy Profile

    • The $50K will kill most of our liquid reserves – almost everything else is in retirement accounts that we’d have to pay a penalty to use which would outweigh the benefit by a lot.

  • I was leaning towards 2 as well, with the option to make it a 3 should you need the money for more time. 5.99% is not a great rate to buy another property, but it can make sense if you want to pay it off very early, and avoid the mortgage costs and early penalties. It is a great rate for a cash flow advance too, if you have to fix something around the house or a cash emergency.
    If you think your in laws will keep their $50K cash, you could close the HELOC and borrow again with them if you have another investment coming up.
    Pauline recently posted..Friday recap, back “home” and ready to run!My Profile

    • The 5.9(% was great for us for the lot since it was quick and easy and was open for a quick sale with little paperwork. We paid more interest for a year, but our up front fees were low, so we know we came out ahead vs a more traditional mortgage on the place.
      I hope my in laws put the money in the market, but honestly I’m not sure what their plans for it are.

  • Great analysis Mrs. Pop. That definitely seems like the right call. Paying $120 extra to keep a large source of capital available just in case is not a big deal. You are probably going to be fine, but it’s good to always be able to draw on an emergency source. Plus, when you start talking about the types of payments you’re making, in the tens of thousands, $120 for insurance is an easy call.
    CashRebel recently posted..How To Run Marathons On A BudgetMy Profile

    • There’s definitely an element of peace of mind in knowing it’s there just in case, too. On some level Option 3 would be great if it just weren’t so darned expensive to keep paying those flood premiums!

  • I had no idea HELOCs were so pricey even if you weren’t tapping them.

    How much extra would it cost you to pay off the parents at the 4th anniversary rather than the 3rd. (I think you’d mentioned earlier that they like getting the loan interest.)
    nicoleandmaggie recently posted..Googled Questions AnsweredMy Profile

    • I blame FEMA and their reclassification. Without that, the flood insurance would not have been needed and the cost would just have been $400 to open it with no ongoing costs.

      As for the extra interest, we pay them 5%/year, so holding off repayment until Feb would be another $1,250, and until August 2014 would be another $2,500. Paying a little extra to keep the HELOC open seems pretty trivial by comparison.

  • Option 2 sounds like the best option until you rebuild your cash reserves. I would keep it open until you have enough cash in your reserves, then close it.
    Savvy Financial Latina recently posted..How Much House Can You Afford?My Profile

  • Option 2 sounds perfect for your needs, and you can always switch to option 3 down the road if needed. I’m loving hearing about your investment/debt repayment plans, keep up the hard work!
    Kyle @ Debt Free Diaries recently posted..Favorite Days of the MonthMy Profile

    • Thanks, Kyle! And you’re right that choosing option 2 now doesn’t negate opting for option 3 in another year if things change and we decide to keep the line open!

  • Anne

    Option 2 seems to be the consensus, and in the scheme of things $120 isn’t a large cost for the security and is probably what I would do in your shoes, but for the sake of argument I’d like to bring up a point about Option 1. Since you expect to rebuild your cash reserves at ~3K/month you aren’t looking at 2 years of maybe-needing-the-HELOC-$, just a few months of it. You and Mr. POP likely have impeccable credit, and should you need to replace another A/C unit or something major in those few months you could probably open a new credit card with a 0% teaser rate for 12-18 months and save that $120, seeing as how I’m positive you would pay off that card ASAP.

    • Good point, I hadn’t even thought of that. We do have good credit – though we’d have to rely solely on Mr. PoP’s credit for any card we needed to open quickly as mine is entering a 7 year extended fraud alert that makes it tough to get instant approval for credit. (It’s because of the whole identity theft drama from a few months back.) Annoying, but not the end of the world. Hopefully that wouldn’t muck up the process too much.

      You’ve definitely given us food for thought… I’ll have to chew on this one for a bit. Thanks Anne!

  • I like option 2, but I’d add that I’d keep the flood insurance, having had friends get hit by rare floods they weren’t insured for.
    Jenny @ Frugal Guru Guide recently posted..Skip Insurance For Generic Prescription SavingsMy Profile

    • I think we’ll continue to research and re-evaluate it, it just seemed very far fetched to declare this area that’s at least 30 minutes drive from the beach and not near any rivers an equivalent flood zone to our house which is 1.5 miles from the beach, on a small lake, and has a river half a mile away.

  • Sounds like a unanimous crowd. Enjoy the weight that’s lifted off your shoulders this summer!
    Mr. Bonner recently posted..The call to lower our TV/internet billMy Profile

  • trudy

    FEMA doesn’t go around reclassifying places for no reason. I would think about keeping flood insurance.

    • This one was really controversial because of how far inland it is and not near any major water ways. To a lot of people it seemed very arbitrary. We’ll keep researching it as we have a couple years to decide if we’re going to pull the plug on the flood insurance permanently…

  • […] Planting Our Pennies wants to know if they should close their home equity line of credit early or not. […]

  • If the only cost of keeping the HELOC open is the flood insurance, I’d just keep paying the flood insurance. Even without the HELOC the flood insurance makes sense as your house is classified as being in a flood risk area. When and if a flood occurs and you don’t have flood insurance, you should expect your regular homeowners insurance company to laugh at you when you try to recover your damages – because legally they’ll owe you nothing.

    Bottom line: keep the flood insurance, keep the HELOC, cut back on any idle cash sitting in bank accounts as the HELOC can cover emergencies.
    My Financial Independence Journey recently posted..Portfolio Status: May 2013My Profile

    • I don’t expect the homeowners insurance to pay anything, but the definition of a flood as classified by the FEMA flood insurance policies is fairly narrow and covers only the most catastrophic events. Having seen how the neighborhood drains after tropical depressions drop 15+ inches of rain on it in a couple days, it would take a LOT of rain to get to the point of flooding according to a FEMA classification.

  • It seems to make sense. But…am I reading this right? You’re paying for a line of credit against which you have nothing borrowed?

    I wonder if it would be possible to get a line of credit from an institution that doesn’t gouge you like that? I have a standing line of credit at my credit union. It costs nothing unless I borrow something against it. Admittedly, it’s not 60 grand…but I wonder.

    It’s actually two months’ worth of my former salary. When GDU went berserk by switching payroll vendors at the same time they converted from bimonthly to semi-weekly pay, many employees didn’t get their paychecks. Often they had to wait weeks or even months before they ever saw their pay.

    No doubt the CU would not grant the likes of me a line of credit now, since I have no salaried income. Surprisingly, though, they didn’t take it away after they learned I’d been laid off.

    You have actual incomes and clearly manage money well. So you might be able to get a credit union to provide a line of credit without charging, in effect, usury on a balance of 0 dollars.
    Funny about Money recently posted..Training Prosecutors: It WAS EntertainingMy Profile

    • We’re paying for flood insurance, which is a requirement to have the HELOC as the home is in a recently FEMA classified 100-year flood plain. Before the HELOC, we didn’t have flood insurance on that house since it doesn’t have another mortgage that would require it.

      I’ll have to look into a LOC form our credit union. Wells Fargo kept offering one, but the interest rates on it were in the neighborhood of 10%, so it wasn’t anything that we were particularly interested in.

  • […] Planting Our Pennies, Mr. & Mrs. PoP contemplate a strategy for getting rid of a paid-off HELOC line of credit originally used to help finance their real estate […]

  • I think option two seems like the best of those options, but I do think you could get an emergency credit card if a huge repair came up. Really cool to have your family paid off ahead of schedule. I’ve never borrowed from family, but I think I would be anxious to pay it back as well.
    Kim@Eyesonthedollar recently posted..Solving the World’s Problems From KindergartenMy Profile

    • We do have two emergency credit cards that have probably $12-$15K worth of credit on them with no balance. They don’t have rewards and they’re our oldest credit lines so we just leave them open but lock the cards up.