If you take out a home equity line of credit (HELOC), what can you spend the money on? The answer is simple: whatever you want. But just because you can doesn’t mean you should. This guide explores the most common — and financially sound — uses for HELOCs and other important things to consider before tapping into your home’s equity.
Many homeowners use HELOCs to fund the right home improvements. Renovation projects, such as remodeling your kitchen or bathroom, installing a pool, or adding a spare room, can significantly boost your home’s value.
As your home’s value increases, so does your equity. Even better, the IRS allows a tax deduction on the interest paid on your HELOC for the portion of the funds used to “buy, build, or substantially improve” the property.
Consult with your tax advisor to ensure you have all the information necessary before making this decision.
Buying a vehicle, paying for higher education expenses, covering business start-up costs, or even funding foreign excursions can put a dent in your savings. Major medical bills can be just as taxing on your finances. But you don’t have to deplete your savings to foot the bill.
Consider funding these expenses with a HELOC, as these lines of credit often come with lower interest rates than credit cards and personal loans. You can capitalize on the ability to make affordable monthly payments while potentially saving on interest.
But be sure the benefit of paying the expense from your home’s equity outweighs the risk of taking on additional secured debt. You don’t want to struggle to make payments and risk losing your home because you wanted to fund a special family vacation.
Some homeowners choose to pay off their mortgages using HELOCs. This approach can reduce borrowing costs if you qualify for a more competitive rate than you would if you refinanced your mortgage.
Closing costs are also lower than with a refinance, and you have the luxury of making interest-only payments during the HELOC draw period, freeing up room in your budget.
Despite the appeal of repaying your mortgage early, you could be subject to prepayment penalties by the lender. Even if you’re not, HELOCs come with variable rates, which means your monthly payments will fluctuate until you pay the balance off. Plus, there’s a risk of foreclosure if you fall behind on your HELOC payments.
Most lenders require a minimum down payment of 10% to buy a second home — sometimes more. Whether you plan to use it as a vacation home, secondary residence, or investment property, taking out a HELOC is one way to make a down payment on a second home.
Again, the rates on HELOCs typically beat those of popular funding sources, like personal loans and credit cards. The interest paid on a second home mortgage may also be deductible at tax time. And during the draw period, you can save money on the full mortgage payment for the additional property by only paying interest on the amount borrowed.
Still, there’s the risk of biting off more than you can chew and extending yourself financially. You could find yourself drowning in mortgage payments, which could lead to foreclosure.
If you’re juggling several high-interest credit cards, you can consolidate using a HELOC to make the balances more manageable. Consolidating gives you a single loan (or in this case, a line of credit), often with a monthly payment that’s lower than you’re currently paying on all your debt combined.
Your credit score could see a short-term boost once you pay off your credit cards, and over time. Your score should continue to improve if you manage your HELOC responsibly.
Debt consolidation with a HELOC isn’t without risks, though. Paying off high-interest debt only to make more purchases with the proceeds is a recipe for disaster. Furthermore, trading unsecured debt for secured debt can be problematic and lead to foreclosure if you’re unable to make the HELOC payments.
A HELOC can offer peace of mind as you approach retirement. It provides a cushion for unexpected expenses, which is vital if you expect your earnings to decrease once you retire. Or, a HELOC can cover your living expenses for a brief period while your nest egg continues to grow in interest-earning accounts.
If you plan to stay in your home, you can also use a HELOC to complete modifications that make the home safer, more accommodating, and more livable. That way, you can enjoy your space while you age in place.
If you’ve already paid off all or most of your mortgage balance, you could consider a reverse mortgage for extra income in your retirement years instead. A reverse mortgage gives older homeowners money from their home equity, and you have various options for how to receive the money. For example, rather than a line of credit, maybe you want to get a lump sum or fixed monthly payments.
When life happens, having a cushion readily accessible gives your finances breathing room. Some borrowers use HELOCs as a financial safety net to cover unexpected expenses or stay afloat during difficult financial patches.
This strategy provides an alternative to dipping into your retirement fund and forfeiting potential earnings from compounding interest. However, tapping into an emergency fund from your savings account might be better, since doing so wouldn’t put your home at risk.
Funds are typically accessible during the draw period through online bank transfers or paper checks from your lender. Some banks and credit unions also offer an ATM card linked directly to your HELOC.
It’s worth noting that some lenders impose minimum draw amounts and fees. Be sure to read the fine print to confirm the specifics on how and when you can access your HELOC funds.
Yes, you’re free to use the funds however you see fit. The purchases you’re considering should make financial sense, though, since falling behind on HELOC payments puts your home at risk of foreclosure.
It depends on the terms. HELOCs come with a draw period — usually five to 10 years — during which you can pull funds up to the limit and make interest-only payments. Once the draw period ends, you cannot make additional withdrawals, and repayment of both principal and interest begins. The repayment period can range from five to 25 years, depending on your lender.
It varies by financial institution. Some homeowners get approved and funded in as little as two weeks, while others wait six weeks or longer before receiving the green light to access funds.
Laura Grace Tarpley edited this article.
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