Why plastic might work better

You may have heard recently that “clickable” home ownership has reached an all-time high, thanks to rapidly rising home prices and conservative borrowing on behalf of existing homeowners.

If you haven’t, know that about 48 million homeowners have about $11 trillion in equity at their disposal.

This assumes a maximum loan-to-value (LTV) ratio of 80%, according to ICE’s latest Mortgage Monitoring Report for May 2024.

This number is almost double what it was in early 2018, when it was about $5.5 trillion, which seems unbelievable.

In other words, millions of homeowners with a mortgage have the ability to tap into their home equity, either through a home equity line of credit (HELOC), a home equity loan, or a traditional cash-out refinancing.

The average borrower has access to about $206,0000, up from $185,000 at the same time last year.

Additionally, they can do so while maintaining a 20% ratio between outstanding loan balances and the value of their property.

But because current mortgage rates are more than double their recent lows, borrowers may not be interested in doing any of these things.

Ironically, this will only cause this amount of exploitable equity to rise, as borrowers continue to avoid borrowing and repay their mortgages.

Instead of a HELOC, why not just use a credit card?

  • If you need cash to renovate your home, you don’t necessarily need to tap into equity
  • It is possible to get a credit card with a fairly high limit and 0% APR for about two years
  • Some contractors even allow credit card payments these days thanks to new technology
  • So there is a possibility to get free financing for small businesses and avoid closing costs!

I know, I know, that sounds crazy and irresponsible. But bear with me here.

I was thinking about this the other day when I was thinking about doing some relatively simple, but still expensive (funny how that works) home improvements.

Let’s say you want to remodel a bathroom and the price will be in the $6,000 range.

Instead of opening a HELOC with your bank, paying closing costs, going through the approval process, and ending up with a second mortgage, you can just open a credit card in a few minutes instead.

But not just any old credit card. The annual interest rate should be 0% for an extended period of time, which will allow you to borrow for free during that period.

This is not necessarily difficult, nor are the offers limited these days. There are plenty of credit cards that offer 0% APR on purchases for up to 21 months or more.

In other words, as long as you make only the minimum payment each month, you won’t pay any interest for an entire year and a half.

Of course, you’ll need to pay off the balance in full within that time to avoid taking on debt once the interest rate adjusts much higher. That’s the trap in these shows.

Let’s say you amortized $6,000 during that period and paid approximately $333 per month to amortize the renovation costs over 18 months.

Although $333 per month may seem expensive, that’s all you have to pay. There’s nothing extra for borrowing that money and paying it back over a year and a half. It’s probably a lot better than parting with the full $6,000 in one shot.

Plus, there are no closing costs, annual fees, early closing fees, underwriting fees, or anything else, as long as you pay off the debt before the APR (0%) period ends.

You can’t avoid interest with a HELOC, and you may pay fees, too

  • Your HELOC will likely be set at a rate of 8% or higher these days
  • You may also have to pay closing costs or an early closing fee
  • It tends to be a longer approval process and you may not qualify
  • It is also another privilege attached to your home

With a HELOC, which may be set at a rate of 8% or higher, you’ll end up paying interest every month and likely some fees to open the thing.

And maybe some fee to close the thing, assuming you don’t keep it open long enough to meet the bank’s requirements. This is known as an “early closing fee.”

Costs can reach $500 to $1,000 or more using our simple example above. Although this may not seem like a lot of money, it is quite high as a percentage of your costs.

We’re talking about 8-16% or higher in terms of the cost of borrowing to do this renovation. Then there are the intangibles, like the ability to allow your debts to be repaid, thanks to having an interest-only withdrawal period on HELOCs.

Or perhaps the temptation to have more money to do other things, or perhaps just not considering costs because money (and more of it) is readily available.

This can also happen with a 0% APR credit card, but knowing that the period to borrow at a cheap rate is short and specific, it may motivate you to pay it all off in a timely manner and stay on budget.

Simple jobs may not require a HELOC or home equity loan

The idea here is that for relatively simple jobs, you may be able to get away with using an interest-free credit card instead of a HELOC or home equity loan.

A lot of HELOCs have lines as low as $10,000, but why bother if you can get a credit card with a similar or even higher credit limit, that charges you no fees to open and no interest for a fairly long period?

The only time a HELOC would likely be preferred is if you’re truly spending beyond your means and need a long period of time to pay off the debt.

Or if it’s a large six-figure job; A simple credit card likely won’t be enough to cover the costs.

Another downside to a credit card is the inability to pay with cash or write a check, assuming the contractor has not accepted plastic as a form of payment (although workarounds exist).

So there are limitations, and it’s not necessarily a one-size-fits-all solution, but I think credit cards are overlooked when it comes to small to mid-sized home renovations.

It can make you more budget-sensitive too, which will be another win versus taking out a second mortgage.

Even before the key interest rate rose 11 times over the past two years, this argument made sense.

Today, it seems less attractive for consumers to pay such a high APR. The only possible caveat is that HELOC interest rates may start to decline if/when the Fed starts lowering its interest rate later this year or in 2025.

Read more: How to Pay for Home Renovations: Pros and Cons of Different Methods

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