If you’re a homeowner, your home may just be your most valuable asset. Your home can be a fruitful means to growing your wealth — the amount of time and care that you invest into it can reward you and your family for years to come.
Fortunately, the amount of money you’ve paid towards your mortgage is like an equity savings account — a finite amount that you can draw from when you need it, allowing you options and flexibility to make smart financial decisions.
One great way to tap into this asset is through a Home Equity Line of Credit (HELOC), a revolving credit line that is secured by your home and can be used for large expenses or to consolidate higher-interest rate debt on other loans. While there are a few different options for funding backed by your home’s equity, a HELOC provides a flexible way to access funds when you need them.
What is a HELOC?
As mentioned above, A HELOC is a line of credit secured by your home that gives you a credit line to use for expenses or debt consolidation. A HELOC is often cheaper than other forms of credit and allows homeowners a low-interest opportunity to leverage a valuable asset they already own — their home’s equity.
A HELOC functions is typically offered as a variable-rate product with a revolving credit line (similar to a credit card), but instead of using your credit score as a primary basis for approval, the amount you are eligible for is based on the amount of equity you have in your home. This means you can borrow against the line for a specific amount and pay it back over time. Additionally, you can continue to make payments toward the balance, opening up your available credit line each time you do so.
How Do I Know How Much I Can Borrow?
If you have equity in your home (the market value of your home exceeds the loan balance), you can typically borrow up to 85% of your equity, depending on the lender you choose and other factors.
What Is Home Equity and How Do I Calculate It?
Home equity can be calculated as the current market value of your home, minus what you owe. A gain in home equity comes from paying down the balance of your mortgage, and/or an increase in your home’s market value over time.
For example, if your home is appraised at $400,000 and the remainder of your mortgage balance is $150,000, that would give you $250,000 in equity.
(market value – mortgage balance = equity)
Importantly, if you believe your home has gained value since you purchased it, consider getting an appraisal before you apply for a HELOC. This will potentially give you access to more funds if you need them.
There are other factors at play in determining the amount of your HELOC, but understanding how to calculate your home’s equity value will give you a good starting point.
How Does Repayment Work?
During the HELOC “draw period”, you can generally make interest-only payments on what you’ve borrowed. Depending on the terms of your HELOC, you may also be able to make payments toward the principal amount, if you choose; however, fees may apply.
You don’t have to withdraw the entire amount of funds — that is the maximum available should you need it. The draw period is usually up to 10 years, depending on the lender and the terms of your agreement.
After the draw period ends, you’ll no longer be able to spend from the HELOC. You’ll enter into the “repayment period”, where you’ll need to pay back the loan. Depending on the terms of your HELOC, this could be over time or due immediately. Typically, the repayment period lasts between 10-20 years, giving homeowners ample time to pay back. Understanding your HELOC’s rate and term structure is key to properly managing your funding.
Benefits of a HELOC
The benefits of a HELOC are significant. From low-interest rates to flexibility, versatility, and even tax deductibility, it’s an outstanding option that many homeowners.
1. Low-Interest Rates
One of the biggest advantages of a HELOC is its low-interest rates. Because the loan is secured against the equity of your home, lenders can offer lower interest rates than other forms of unsecured loans (like personal loans and credit cards).
It’s important to note that unlike a fixed-rate loan, HELOCs typically have variable interest rates, which means they are subject to fluctuation as dictated by federal interest rates.
Additionally, by obtaining a HELOC through a credit union, you are likely to find lower interest rates and fewer fees than through a for-profit bank. Because credit unions are not-for-profit, they tend to have their members’ best interest in mind, and will offer personalized service to get the best options available to you.
Another benefit of a HELOC is its flexibility. Differing from traditional loans where you receive a lump sum payment upfront, a HELOC is a revolving line of credit that allows you to access funds as needed.
You can borrow up to your credit limit and pay it back over time. And, because you only pay interest on the amount you borrow, you receive a money-saving benefit.
3. Tax Deductibility
Often, the interest paid on a HELOC is tax-deductible. For example, if you use the loan to buy, build, or substantially improve your home, the interest may be eligible to be deducted.
Keep in mind that this deduction only applies if you are using the funds to improve the property which backs the HELOC. It’s important to consult with a tax professional to determine if you qualify for any tax deductions related to your HELOC.
A HELOC can be used for a variety of purposes. Many homeowners use a HELOC to finance home improvements or renovations, but they can also be used to pay for unexpected expenses, like medical bills or emergencies. Additionally, a HELOC can be used to finance large purchases or to consolidate high-interest debt.
Note: Borrowing against your home has some risk if you are using the funds to pay for things that are outside of your budget and do not add value. Because a HELOC is backed by your home, if you fail to pay it back, the bank could foreclose on your home. While HELOCs typically have generous repayment periods, you risk negating the benefits of your home’s equity if you spend the money carelessly. As such, it’s important to use your funds accordingly.
Ways to Use a HELOC to Maximize Your Home’s Equity and Grow Your Wealth
With that in mind, we’ll examine four great ways to boost your finances by taking advantage of a HELOC.
- Home Improvements & Renovations
- Debt Consolidation
- Purchasing Additional Real Estate
- Emergency Expenses
1. Home Improvements and Renovations:
The most popular use for a HELOC is home and property renovations; rightly so, as one of the best ways to grow your wealth is to invest in your home and property. As you raise the value of your home, your wealth potential grows too. As previously discussed, your home’s equity grows when its value increases.
Investing in renovations that add value — such as remodeling your kitchen, expanding your home’s square footage with additions, and making structural improvements — help to raise your equity. To use a HELOC for this purpose is a potential means increasing your wealth, while also providing you with added enjoyment and value of your space.
These renovations will most likely pay for themselves by increasing your property’s value. As a bonus, any interest you pay for the HELOC while making improvements or renovations is tax-deductible.
2. Debt Consolidation
If you have high-interest credit card or loan balances, a HELOC can be a good option for consolidating your debt into a single, lower-interest payment. Consider that a typical credit card offers an interest rate between 15-20%, while a HELOC is generally between 5-8%.
By consolidating your debt, you’ll be able to lower your monthly payments and pay off your debt faster. By paying down or eliminating high-interest debt, you automatically keep more of your money in your pocket. The savings in interest over time can be significant.
Be careful and consider why you have this debt in the first place. If you are not financially in a good enough standing to pay off the HELOC, you are risking your home. As such, make sure you have a clear understanding of your ability to manage the repayment.
3. Purchasing Additional Real Estate
Although this option needs careful consideration, purchasing an investment property using a HELOC for a down payment can be a good financial move. Using equity that is stagnant for a rental property can put your money to use and create an additional revenue stream.
Note: Consider the combined payments of any mortgages and HELOCs to understand your finances and your ability to afford the payments. Defaulting on either of them can be problematic.
4. Emergency Expenses
No one likes to think about emergencies, but they can happen at any time. If you’re faced with unexpected expenses like medical bills or surprise home repairs, a HELOC can provide the funds you need to cover these costs without having to resort to high-interest credit cards or personal loans.
If you don’t have a current need for the funds, it could be to your benefit to set up a HELOC anyway (so that you’re equipped for these types of emergencies). Keep in mind that you won’t pay interest on the amount of the line that you don’t use, so it can prove to be a wise financing option should you need it.
HELOC vs. Other Types of Funding
Now that you have a solid understanding of a HELOC’s function and uses, let’s look at the advantages a HELOC has over other forms of funding.
HELOC vs. Home Equity Loan
A HELOC is not the only form of financing that is secured by your home equity. A Home Equity Loan (also known as a second mortgage) is similar but with some distinct differences.
The main advantage of a HELOC is flexibility. Instead of taking a lump sum of money that you have to begin payments on immediately, you can use a HELOC as you go, avoiding paying interest on the entire amount if you’re not ready to use it all at once.
It’s also reusable, meaning that you can use the funds, pay it off, and use it again as many times as needed during the draw period. This eliminates the need to re-apply for funding.
HELOC Versus Other Lines of Credit or Personal Loans
Credit cards and personal loans typically can come with a hefty interest rate, sometimes up to 20% or even higher. When thinking about your financial future, savings via lower interest rates can really add up over time. With rates often less than 10%, a HELOC can be a wise choice over these types of loans.