Best Uses for a Home Equity Line of Credit (HELOC)
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Even with the range of financing options available today, homeowners have a unique advantage.
After you’ve built up enough equity in your home, you may be able to borrow against that amount through a Home Equity Line of Credit, or HELOC. Because HELOCs are secured by an asset (your home), they are one of the most popular ways to borrow at lower interest rates, especially when you face high costs for needs like like home renovations, tuition or debt consolidation.
HELOCs are generally easy to obtain if you already have at least 15-20% equity in your home and may offer some advantages, such as lower interest rates or longer loan terms, compared to other forms of financing such as personal loans and credit cards. A type of revolving line of credit, a HELOC can also offer interest-only payments. And unlike an installment loan, borrowers can access their HELOC over and over as they pay off the balance (much like a credit card).
But before you take out what is often colloquially referred to as a “second mortgage,” you need to determine exactly how you plan to use a HELOC, along with a few alternatives that won’t put your home at risk.
In this article, we’ll share six ideas on using a HELOC. In addition, we will offer you three alternatives if you decide that a HELOC is not for you.
Is a Home Equity Line of Credit a Good Idea for Me?
HELOCs can give homeowners flexible and essential access to credit on an ongoing and revolving basis, if they can meet the requirements. Once established, these lines of credit can serve as a useful back-up funding pool for projects that exceed your daily budget.
That said, HELOCs have fees and conditions that every borrower should be aware of. Depending on the size of your HELOC, you may have to pay closing costs to apply for and use your line of credit. These fees may include the costs of setting up, subscribing, closing and registering your loan. Additionally, some HELOCs have initial restriction periods, ranging from a few months to a few years, during which you may have to pay a prepayment penalty or early termination fee to pay off the loan or close the line of credit. Different lenders may charge different fees, and some may even waive certain fees, so be sure to ask your lender exactly what you will be paying.
Make sure you shop around with several lenders to make sure you get the best deal. Don’t just look at the rates either; Also be sure to factor in fees and the total cost of borrowing.
Banks typically advertise âno chargeâ HELOCs that require no cash to open and that are delivered without prepayment penalties. Your bank may offer targeted discounts based on your existing relationship and your account balances. In addition, some lenders offer introductory prices that further reduce the rate during the first few months of opening your HELOC. Do your research thoroughly before you apply – and remember that even a âno-costâ HELOC will at least charge interest.
Advantages and disadvantages of a HELOC
Notably, HELOCs are known to offer interest-only payments, which makes them an even more attractive option for flexible financing. However, with every benefit comes a caveat, according to Casey Fleming, mortgage advisor for Fairway Independent Mortgage Company.
âToo many people pay only the minimum payment on their HELOC,â says Fleming. âThey end up paying for this shopping spree for the next 25 years. Only go this route if you intend to pay off the balance quickly, âshe says.
Here are some additional advantages and disadvantages of purchasing a HELOC:
May offer interest payments only for the first year (s)
Can provide borrowers with access to revolving credit worth up to a certain percentage of their home’s value (typically 85%)
Interest may be tax deductible if the funds are used to improve the value of your home
Can be used as you want
Interest-only payments require additional discipline and may encourage spending beyond your means
Could charge closing costs, like on a primary mortgage (but not always)
You generally need at least 15% to 20% of your home equity to qualify
Failure to repay could lead to foreclosure of your home
5 common uses of a HELOC
You don’t have to use a HELOC for household-related expenses only.
If you are wondering what else you can use a HELOC for, here are some options:
HELOCs are “especially useful for home improvement projects when you don’t know what the final cost will be,” says Michelle Lambright Black, credit expert and personal finance writer. Construction projects are known to go over budget or change the scope halfway through, and you don’t want to run out of cash before your project is finished.
Many people use HELOCs to consolidate high interest debt and reduce their monthly payments. This strategy can work, as long as you have an ultimate plan for paying off the debt.
According to Lambright Black, a “hidden benefit” of using a HELOC to pay off credit card debt is that it can improve your credit score. Credit bureaus do not consider HELOC use in credit scoring, so moving credit card debt to HELOC could lower your reported credit utilization rate. Such an increase in your score could help you qualify for better rates and terms on other loans.
Buy another property
If you want to buy a vacation home or rental property, a HELOC can simplify the process. Assuming the equity in your home is comparable to the cost of another, using HELOCs as opposed to a traditional mortgage could help you bypass the typical 30-60 day underwriting process.
Assuming you can afford to ‘cash in’ your HELOC, your offer on a new home could be considered stronger than competing buyers because it would not depend on bank financing.
An emergency relief fund
The general rule is that you should have an emergency fund that covers three to six months of expenses. While this is ideal, the reality is that most families don’t have much left for emergencies. A HELOC can serve as a backup to your emergency fund in the event of the unexpected.
Cover business expenses
Business owners can often use a HELOC with lower rates than those charged on a small business loan. Additionally, a HELOC does not require your business to be open for two years before being approved, as most small business loans do. The HELOC can be used to start a new business, cover current expenses, or expand an existing business. But be aware of the risks associated with investing in a business using your home as collateral.
Alternatives to a Home Equity Line of Credit (HELOC)
If you are in need of financing but don’t think a HELOC may be the best option for you, here are some alternative ways to get the financing you need:
Refinancing of collection
With interest rates near historic lows, refinancing your existing mortgage can guarantee low rates for the next 15 to 30 years. According to Fleming, refinancing with cash “is a good idea if your current mortgage doesn’t have a low interest rate.” And, because a traditional mortgage payment includes both principal and interest, your balance is reduced with each payment. In comparison, payments on an interest-only HELOC during the drawdown period would not reduce your principal balance.
Promotion credit card 0% APR
Many credit cards offer an interest-free promotional period when you first open the account. These 0% APR promotions can be used for purchases, balance transfers, or sometimes both. Some of these promotions can last up to 18 months or more. While some banks charge a balance transfer fee of 3% to 5%, they generally do not charge a fee on purchase promotions.
âThese offers are a good idea if you can pay off the balance before the promotion expires,â says Lambright Black.
Personal loan or line of credit
Although personal loans or personal lines of credit may have a higher interest rate, they can usually be opened very quickly. In some cases, borrowers can see the cash in the bank account on the same day as their request.
During this time, most HELOCs require evaluation, and it may take a few weeks for the subscription to be approved. Not to mention that HELOCs sometimes require you to keep the line of credit open for at least a few years. Therefore, if you need the cash quickly for a specific purpose (and plan to pay it off quickly), personal loans may be preferable in this scenario.