Should I invest money from a home equity line of credit?
I am in the process of having a covered porch added on to our house. The projected budget will be around $70,000 when all is said and done. We have saved up to pay cash for it, but my bank has offered a home equity line of credit (HELOC) with 12 months fixed interest at 3.49 percent. Should I take the HELOC and invest the funds for 12 months in a CD or high yield savings account? I have seen rates around 2.5 percent for CDs, so effectively my interest rate would be 1%.
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Since you have already saved up the money, it would be best to use the cash to pay for the addition and avoid the home equity line of credit (HELOC). Taking out the HELOC would cost you interest, even if it is a small amount, and there is no reason to pay your bank the interest if you don't have to. The following three scenarios may help.
SCENARIO 1: Get the HELOC and Invest
In this scenario, you would get a $70,000 HELOC and invest the $70,000 cash in the 12-month CD. The interest you pay on the HELOC would be $2,443, while the interest earned on the CD is only $1,750. Effectively, you pay $693 more interest than you earn. Worse still, though the HELOC interest may or may not be tax-deductible, you will get taxed on the CD interest, which is not tax-efficient and would cost you more money. The HELOC interest can be tax-deductible, but you need to talk with a CPA about your specific situation. Even if the HELOC interest is tax-deductible, you would still end up losing money on the deal.
SCENARIO 2: Pay Cash
In this scenario, you forgo the HELOC and pay cash for the addition. Of course, the cash wouldn't be needed all at once, so let's assume you have $35,000 in your savings account for 6 months of the year. Currently (October 2021), you can up to 0.6% in a standard government-insured savings account at an online bank or credit union. In this scenario, you would pay no interest to the bank but still earn $105 in interest on the money while the addition is constructed (maybe just enough to buy an outdoor ceiling fan).
SCENARIO 3: Get the HELOC and a Mistake
Even if the interest rates were reversed and the HELOC was cheaper than the CD, I would still be hesitant to recommend taking out the HELOC. While the loan interest rate is fixed for 12 months, it will start climbing after that point. If you ended up spending the CD money due to an emergency or some other reason, you would be left paying off a HELOC charging you ever higher interest. For a few hundred dollars, the risk usually isn't worth it.