6 reasons to use a HELOC

Over time, your home can become a powerful financial tool. As property values rise and you pay down your mortgage, you build home equity — the difference between what you owe on your home and what it’s worth on the market. Lenders may allow you to borrow against this value, giving you access to money you can use for a variety of financial goals, like fixing up your home, covering medical bills or sending a child to college.

You can borrow from your home equity in three main ways: a home equity loan, cash-out refinance or home equity line of credit (HELOC). In this article, we’ll go over how HELOCs work, their advantages and disadvantages, and some reasons you may want to use one.

What is a HELOC?

A home equity line of credit, commonly known as a HELOC, is a flexible way to borrow against the value you’ve built up in your home. It’s a type of credit line that functions much like a credit card. When you open up a line of credit, the lender gives you a maximum amount you can borrow based on how much equity you have in your home. Then you can spend from this account up to your limit, typically using checks or a card connected to the account.

HELOCs begin with a draw period, when you can use your line of credit as many times as you like. You’re usually only required to make small payments during the draw period, often paying only the interest. Then you’ll enter your repayment period, when you’ll pay back the full amount you spent, plus interest. HELOCs are typically repaid with a variable interest rate, which can go up or down based on the market.

This sets HELOCs apart from other ways you can borrow against your home equity, like a home equity loan or cash-out refinance. With a home equity loan, you borrow a lump sum of money based primarily on how much equity you have in your home. You’ll immediately start to pay back this loan, usually with a fixed rate.

With a cash-out refinance, you take out a new mortgage that pays off and replaces the one you currently have. Your new mortgage is for a higher amount than you currently owe, with the difference coming to you as cash.

WHAT TO KNOW ABOUT GETTING A CASH-OUT REFINANCE ON A PAID-OFF HOME

What can you use a HELOC for?

You have a few restrictions on what you can use a HELOC for. In general, you can use the money however you wish, though your lender may have rules on how you access your account. For example, you may be required to make a minimum initial draw when you first take out the HELOC, or there may be a minimum amount you must borrow each time you use the line.

Here are six reasons why people use HELOCs:

• Consolidating debt — If you have a pile of credit card bills, you may be able to use a HELOC to consolidate your debt — paying off your cards and climbing out of debt at a lower interest rate.
• Fixing up your home — HELOCs can be a good way to pay for critical home maintenance, renovations, or additions. You may even be able to deduct the interest you pay on your federal taxes if you use the money to improve your home.
• Paying for college — Tuition and other higher education expenses can be costly, and a HELOC can help you pay these bills when they come due.
• Putting a down payment on a second home — It can be harder to qualify for a mortgage on a vacation home or rental property. You may be able to use a HELOC on your primary residence to help make your down payment.
• Covering medical bills — A HELOC can help you get a handle on your medical expenses, especially if you’re struggling after a significant medical emergency.
• Financing a wedding — With a HELOC, you have flexibility to pay for all the different vendors you need for the big day.

Because your property is at stake, home equity lines of credit are best used for critical needs rather than day-to-day spending or extravagant purchases. Think carefully before taking out a HELOC or using the line of credit you have. The more you spend, the higher your monthly payment will be.

What are the advantages of a HELOC?

HELOCs have a number of advantages over other ways you can borrow money, including:

• Flexible borrowing — With a line of credit, you don’t have to borrow all at once. You can spend from your account as you need to, helping you keep your total debt low.
• Only pay interest on the amount you spend — You don’t need to pay interest on your full credit limit. Instead, you just pay interest on what you actually spend.
• Lower interest rates — Because HELOCs are secured by your home, you’ll generally qualify for a lower interest rate than you’d receive on a credit card or personal loan.

What are the disadvantages of a HELOC?

A HELOC may not be the best option in every situation. Like any type of loan, home equity lines of credit also have their disadvantages, such as:

• Variable interest rates — HELOCs typically have variable interest rates, which can go up over time. This can increase your monthly payment, making your costs harder to budget for.
• Risk of foreclosure — HELOCs are secured by your property, meaning you risk losing your home to foreclosure if you’re unable to make your payments.
• Fees and other charges — You may need to pay a variety of fees associated with your HELOC, including an application fee, an appraisal fee, annual fees, transaction fees, and even an "inactivity fee" if you don’t use your line often enough.

How to get a home equity line of credit

Taking out a HELOC is a relatively simple process, but it’s important to get it right. These steps can help you get the best home equity line of credit for your financial situation:

1. Determine how large a line you need. Think about what you’d like to use your HELOC for. If you only need a small amount of money, it may not be worthwhile to use a home equity line. A personal loan or credit card may be a better solution. Lenders often have minimum amounts for their lines of credit, which can range from $10,000 to $25,000 or more.
2. Check on your home equity. Take a look at your mortgage statement to see how much you still owe. Then get a read on how much your home is worth. You can use the valuation from your local government’s tax assessor, or use a site like Redfin or Zillow to see how your home may be valued. In most cases, you can borrow up to 80% of your home equity through a HELOC, so this will give you a good sense of how large a line you can qualify for.
3. Gauge your credit. Qualifying for a HELOC isn’t just based on your home equity. You’ll also need to have good credit. Many lenders have minimum credit scores you must meet to take out a home equity line of credit, often 680 or higher. You can check your credit score by requesting your credit reports from the three main credit bureaus using AnnualCreditReport.com.
4. Prequalify and check rates. Many lenders allow you to prequalify for a HELOC online. After filling out some basic information and going through a credit check, you may receive some preliminary loan offers, including the interest rate and fees you’d pay.
5. Apply for a loan. When you find the best loan offer, your lender will guide you through the full application process. You’ll typically need to provide documents that prove your income and assets, including W-2s, pay stubs, and bank statements. You’ll also likely need to have your home appraised.
6. Close on your loan. Just like when you closed on your mortgage, your HELOC will have a formal closing. When you sign all the paperwork, you’ll soon have access to your line of credit.