Homeowners don't have to wait until they sell their homes to cash in on the time and effort spent increasing its value. It's possible to access a home's equity—the difference between the mortgage balance and market value—without listing the home. A home equity line of credit (HELOC) allows homeowners to tap into their equity now and use funds for current and future needs.
If you own a home, leveraging its equity can be an excellent way to access cash quickly to pay for renovations or improve your financial picture. But it’s essential to use discretion.
What is a HELOC?
A HELOC is a loan based on the equity in your home. It works like a revolving line of credit, similar to a credit card, but with several significant differences. Like a credit card, a HELOC has a preset credit limit that allows you to borrow money as needed and make payments on the balance.
Unlike a credit card, HELOCs require collateral as a condition of loan approval. In this case, the collateral is your home. If you fail to repay the loan as agreed, you risk losing your home.
While you can use HELOC funds as you choose, you can only borrow from the credit line during the draw period. Once the draw period ends, you can no longer borrow money. During the draw period, you will typically be required to only make interest payments. You also may choose to make additional principal-only payments if they can be made within your means. Once the draw period is completed, however, you will be responsible to make repayments on the outstanding balance on what was borrowed, including interest and fees.
For example, a 15-year term HELOC may have a 5-year draw period followed by a 10-year period where you repay the outstanding balance and can no longer borrow funds. The outstanding balance is repaid in equal monthly installments. Draw period and repayment terms vary by lender.
Advantages of using a HELOC
Homeowners often need to cover planned and unplanned expenses. Whether you're looking to cover college tuition this fall or just received a termite damage repair bill, HELOCs provide a way to borrow funds when you need them.
You can access the money by transferring funds between accounts, writing a check, or withdrawing cash when visiting a branch location. HELOCs are an attractive option when compared to personal loans or credit cards due to their:
Low monthly payments
During the draw period, some lenders may require interest-only payments. This can help lower overall borrowing costs. HELOCs only require you to repay what you've borrowed.
Low initial fixed rates
You can expect lower interest rates when compared to personal loans and credit cards. Some HELOCs come with no annual fees, prepayment penalties, or point fees. NOTE: Fixed-rates may apply to the funds borrowed during the draw period but may change to a variable rate during repayment.
Traditional loans provide funds in one lump sum with repayment beginning shortly after you receive the loan. But HELOCs allow you to decide the best time to borrow money. For instance, you could use loan funds on home improvements today, and again on college tuition next year.
HELOCs only require you to apply once for approval. There's no need to re-apply each time you need to access your credit line. To increase your available balance, just repay some of the borrowed amount.
Potential tax benefits
If you use loan proceeds to substantially improve your primary residence or second home, you may be eligible for a tax deduction on the interest payments. Consult with your tax advisor to see if this applies to your situation.
Best ways to use HELOC funds
HELOCs can meet almost any financial need or goal. Some common uses for HELOC funds include:
- Debt reduction or elimination
- Buying a second home or rental property
- Major home renovations or minor improvements
- Paying for college-related expenses
- Upgrading to energy-efficient appliances
- Using funds for emergency expenses in the absence of a fully-funded emergency savings account
You decide how best to use the funds based on your unique situation.
The equity in your home can provide the funds you need to meet a specific financial goal. It could also help you secure a low-interest, stress-free way to make sure you have the money you need when you need it.