A home equity line of credit (HELOC) provides homeowners with a flexible line of credit backed by the equity in their homes.
This revolving line of credit can be used to fund a home improvement project, consolidate debt and a range of other financial goals.
Throughout this article, we’ll explore the ins and outs of HELOC loans and what to consider before taking one out.
What a HELOC can be used for
A HELOC allows homeowners to borrow anywhere from 75% to 90% of their home’s value.
It’s a versatile tool that’s similar to a home equity loan, though there are some key differences between the borrowing options. A home equity loan provides a lump sum of money upfront, with a fixed interest rate and fixed monthly payments over a specified term. HELOCs, on the other hand, offer a revolving line of credit with a variable interest rate, allowing you to access funds as needed.
Here’s a breakdown of what a HELOC is traditionally used for:
Home improvement projects and renovations
From remodeling a kitchen to upgrading a tired landscape, home improvement is one of the most frequent motivations for taking out a HELOC.
By leveraging the equity in your home, you can access a substantial amount of money at a competitive interest rate — all while, ideally, increasing your home’s value.
HELOCs are particularly well-suited for financing home improvement projects that will be carried out in several stages, since they allow borrowers to withdraw money on an as-needed basis. Many homeowners, for example, use HELOCs to gradually add accessibility and “aging in place” amenities (like handrails and wheelchair-friendly bathrooms) to their homes.
Plus, if these renovations increase the value of your home, the interest paid on the HELOC could be tax-deductible.
If you have high-interest debt from credit cards, a personal loan or otherwise, you might want to consider using a HELOC to consolidate it.
Paying off debt with a HELOC can streamline your financial obligations into a single (and hopefully, more manageable) monthly payment. Typically, the interest rates on a HELOC are lower than those on unsecured personal loans and credit cards, which could ease your financial burden even further.
As the cost of a degree grows ever higher, many families are struggling to pay for college.
If you can get a lower interest rate for a HELOC than you can for a student loan, this could be a more affordable option when it comes to paying for tuition, textbooks and other related costs. But weigh your options carefully: Student loans don’t use homes as collateral, but if you default on a HELOC, you can lose your house.
Buying an investment property
Real estate investments can be lucrative. With a HELOC, you can use the equity in your primary residence to make a down payment on another property, or pay for it outright.
Some homeowners tap HELOCs to buy rental properties or vacation homes. Others use a strategy called “piggybacking” to buy a second home while keeping their old one as an investment property. This is one way you can use a HELOC to build wealth.
As with any big financial decision, you should assess your current financial situation, evaluate the potential risks and create a plan to meet the obligations associated with taking out a HELOC before buying another house. Be sure to read the fine print, too: If you sell the home used as collateral for the HELOC, you’ll probably have to pay the remaining balance immediately.
Unforeseen medical expenses can put a significant strain on your finances. Paying off this debt with a HELOC is an option, but it’s probably not the best one.
By using a HELOC to cover medical expenses, you typically forfeit the right to access hospital financial assistance programs and other resources that can ease your financial burden. You also forfeit the federal protections that come with having debt that’s categorized as “medical,” which can decimate your credit score. And since HELOC loans use your home as collateral, you risk foreclosure if you default.
Personal finance experts typically recommend keeping at least three to six months’ worth of living expenses in an “emergency fund” that’s separate from the rest of your assets. If you’ve already depleted that safety net, it can be tempting to look to debt options like HELOCs for quick access to cash. Be forewarned: This usually leads to a perpetual cycle of increasing debt and years of financial instability.
Additionally, be aware that the “draw period” of a HELOC, during which you can access funds, typically spans about a decade. After this period, you'll need other sources of emergency funding.
Business ventures and entrepreneurship
Starting or expanding a business often requires a significant injection of capital. If you have entrepreneurial aspirations, a HELOC is one method of financing those endeavors.
Whether you need funds for equipment, inventory, marketing or operational costs, a HELOC can provide the necessary capital to help you achieve your goals. However, it's essential to assess the potential risks and returns associated with your business plans before using a HELOC.
Legal matters can be costly, and not everyone has readily-available funds to cover attorney fees. By utilizing the equity in your home via a HELOC, you can finance a range of legal services, including divorce, estate planning and more.
Can you use a HELOC for anything?
While a HELOC offers flexibility, there are some limitations to keep in mind. Before you take the plunge, consider all the pros and cons of a home equity line of credit (HELOC).
Regardless of your current state of financial affairs, there are certain expenses that probably shouldn't be financed with a HELOC. Using a HELOC to buy luxury purchases, speculative investments or high-risk ventures is generally not advisable.
Remember: When you take out a HELOC loan, you borrow against the equity in your home. If the assets you acquire don’t retain their value, they might not cover the balance of your HELOC, which could quickly put you underwater.
Can you use a HELOC for a down payment on a car?
Using a HELOC for a down payment on a car is technically possible, but it’s probably not wise.
Vehicles lose value, or depreciate, over time, so you could find yourself repaying your HELOC after your car bites the dust. Using a HELOC to buy a car can also put your home at risk if you go through a period of financial hardship and can’t make the loan payments. All said, an auto loan is usually the better choice.
Is it smart to use a HELOC to pay off a mortgage?
Paying off your mortgage with a HELOC might seem appealing, but be sure to do your due diligence. Even if you’re able to consolidate your debts and streamline your monthly payments, there are other factors to consider. Using a HELOC to pay down a mortgage means you’re converting a long-term, fixed-rate loan into a variable-rate loan, which can be risky in a rising interest rate environment.
Likewise, the repayment terms for a HELOC may differ from your mortgage agreement. Consult a financial advisor or mortgage professional to evaluate the potential benefits and risks before you take the plunge.
Home equity loan vs. HELOC uses
How you plan to use the money you borrow will determine whether you need a home equity loan or a HELOC. Both allow you to tap into your home equity, but there are key differences to each product. A home equity loan provides a lump sum with a fixed interest rate and a fixed monthly payment, making it well suited for financing one-time expenses or specific projects.
HELOCs, on the other hand, offer a revolving line of credit with variable interest rates, providing more flexibility for ongoing or multiple expenses.
Summary of what you can use a HELOC for
In summary, you can use a HELOC for various purposes, including:
- Home improvement projects
- Debt consolidation
- College education
- Real estate investing
- Medical expenses
- Funds for financial emergencies
- Business ventures
- Legal services
- Travel expenses
It's essential to consider the potential risks and rewards associated with how you plan to use your HELOC. Remember to consult with a trusted financial professional, evaluate your long-term financial goals and create a solid repayment plan.