If you’re a homeowner, you can be proud of the equity you’ve built in your home. You’ve worked hard to manage your mortgage and make on-time payments. Now, it might be time to make your home equity work for you.
A home equity line of credit (HELOC) can help you fund major expenses like renovations or repairs. But as with any line of credit, there’s a right and wrong way to use it.
Is a HELOC a good idea for you? Here, we’re offering an explainer on HELOC loans and how they work and answering common questions about the best (and worst) ways to use this type of loan.
What is a HELOC?
A Home Equity Line of Credit, commonly called a HELOC, is a type of loan that allows you to borrow money against the equity in your home. Equity is the difference between the current market value of your home and your outstanding mortgage balance.
A HELOC is a line of credit, similar to a credit card. It allows you to borrow up to a certain limit, pay the money back, and then borrow again. The amount of money you can borrow depends on your credit score, the amount of equity in your home, and other criteria set by your lender.
How does a HELOC work?
Here’s how a HELOC typically works, from the time of application through the term of the loan:
Apply for a HELOC.
Applying for a home equity line of credit is a lot like applying for other loans. You’ll provide documentation, such as proof of income and home ownership, and the lender will assess your eligibility.
If you’re approved for a HELOC, the lender will determine your credit limit based on your creditworthiness, the amount of equity in your home, and other factors. Your credit limit is the maximum amount you can borrow.
Withdraw and use funds.
After your credit limit is set, you can begin to draw funds from your HELOC up to that limit. Your HELOC can be used for any expenses within the terms and conditions of your loan agreement.
Repay the loan.
HELOC loans come with a draw period, which lasts for a set number of years (typically 10). During the draw period, you will make minimum payments against the amount you borrow.
Reuse the credit.
A HELOC loan is a revolving line of credit, similar to a credit card. As you pay down your loan balance, you can continue to draw funds up to your credit limit.
Pay off the loan.
At the end of your HELOC draw period, you have a set amount of time (typically 20 years) to repay your outstanding balance. You can pay off the loan in full, or you may be able to refinance or convert to a fixed-rate loan.
It’s important to understand that a HELOC is a secured loan, which means your home is used as collateral. If you’re unable to repay the loan, the lender may foreclose on your property to recover what you owe. This is why you want to borrow responsibly and only draw what you know you can repay.
Additionally, a HELOC often comes with fees, such as application, appraisal, or annual fees. Make sure you understand the costs associated with this type of loan before deciding if it’s the right choice for you.
Is a HELOC right for me?
There are several reasons why you might want to consider a HELOC:
A HELOC can give you access to funds as needed and serve as a source of funds when unexpected expenses arise.
Lower interest rates.
A HELOC often comes with lower interest rates than other types of credit, making it a cost-effective way to borrow money for large expenses.
The interest you pay on a HELOC may be tax-deductible if the funds are used for home improvements or other qualified expenses.
Home equity growth.
A HELOC allows you to tap into the equity in your home and use it for expenses while allowing you to maintain ownership of your home.
Can you use a HELOC for anything?
You can use a HELOC loan for any purpose within the terms and conditions of your loan agreement. Lenders may place restrictions on how you can use a HELOC. For example, some lenders may require you to use the funds for home improvements or other approved expenses, while others may allow more flexibility.
But even with loose restrictions, it’s wise to be careful how you use your HELOC funds. It’s generally recommended that you use a HELOC for expenses that are necessary or have the potential to improve your financial situation. Using a HELOC to fund non-essential expenses may not be the best use of your home equity and could put your home at risk.
How do you use a HELOC loan the right way? Some great ways to use a HELOC include:
Home improvements or home repairs.
You can use a HELOC to fund home renovations like upgrading your kitchen, replacing appliances, or installing a new roof.
If you have high-interest credit card debt or other unsecured loans, you can use a HELOC to consolidate that debt and potentially save on interest charges.
You can use a HELOC as a source of funds in case of an emergency or unexpected expenses, such as medical bills or costly car repairs.
Planning for retirement
If you’re nearing retirement, you can consider using a HELOC to supplement your retirement income.
What are some of the wrong ways to use a HELOC? Bad ways to use a HELOC include:
Buying a car
Paying for a weddings
Starting a business
While a HELOC can be a useful tool for accessing additional funds, there are several reasons to avoid using it for non-essential expenses like these:
Your home is at risk.
Remember that a HELOC is a secured loan, and your home is used as collateral. If you can’t make the payments and default on the loan, the lender could foreclose on your home.
You’ll pay interest.
Although a HELOC loan often comes with a lower interest rate than a credit card or a personal loan, there are still interest charges. A HELOC interest rate is usually variable, which means it can fluctuate over time based on market conditions.
You can find yourself in a cycle of debt.
Using a HELOC for non-essential expenses could lead you into a debt spiral. If you’re unable to pay off your loan, it could negatively impact your credit score and make it difficult to get credit in the future.
A home equity line of credit can be a powerful financial tool for homeowners. Using a HELOC loan the right way can help you make home improvements, consolidate debt, and more. But using a HELOC the wrong way—to finance long-term or non-essential expenses—can lead to financial trouble. Before deciding if a HELOC is right for you, consider your financial situation and borrowing needs.
August 1, 2023
Medical debt is a concerning financial situation faced by many individuals and families. Unexpected medical expenses can lead to substantial financial strain, impacting credit scores…