How Home Equity Lines of Credit Work
A HELOC is a revolving line of credit that uses your home's equity as collateral. It works like a credit card, but instead of a pre-set credit limit based on your income and credit score, your borrowing power mainly comes from the value you've built up in your home.
You can borrow money as you need it during what's called a ‘draw period’ (up to 10 years), and you only pay interest on what you actually use. After the draw period ends, you enter the repayment phase (up to 20 years) where you pay back the amount you borrowed plus any unpaid interest.
HELOC interest rates may change each quarter, but they are usually lower than credit cards or personal loans.
Best Times to Use a HELOC for Unexpected Costs
A HELOC can be a smart tool for unbudgeted expenses, especially larger ones that you can realistically pay back over time. Here are two common scenarios where it often makes the most sense:
1. Home repairs that protect your family.
When your roof is leaking or your air conditioner stops working in the warm months, you need a fix that protects your finances and your family. A HELOC can give you quick access to the funds you need without derailing your other financial goals.
2. Major medical expenses.
When you face substantial medical bills that your health insurance doesn’t cover, a HELOC can help. Its longer repayment terms and lower interest rates can make managing those costs more affordable than carrying the balance on a high-interest credit card.
Surprise expenses have a way of appearing, and sometimes reappearing, when you’re least prepared. Fortunately, a HELOC can be used, repaid, and used again without the need to submit a new loan application.
When to Think Twice About Using a HELOC for Emergencies
While a HELOC can be helpful, it's not always the best solution for unexpected bills.
- Small, short-term expenses. If you need $500 for a minor repair or $1,000 for an unexpected expense, the closing costs and fees associated with opening a HELOC (which can run $500-$1,000 or more) might not make financial sense.
- When job security is uncertain. Since you're using your home as collateral, taking out a HELOC when your income is unstable or you're facing a potential job loss adds more risk to an uncertain situation. If you can't make HELOC payments, you could lose your home.
- If you don't have a realistic repayment plan. Review your budget to see if you can comfortably pay back what you borrow. Without a clear plan to repay the debt, you could find yourself with mounting interest charges and a shrinking equity cushion.
The right choice usually depends on your current expenses, your home’s equity, and your ability to manage the repayment. Being honest about your circumstances can help you make a decision that protects your home and addresses your financial needs. It’s also important to remember that HELOC interest rates are often variable, meaning monthly payments can increase if rates rise over time.
Tips for Making a Home Equity Line of Credit Decision
If you're unsure whether a HELOC is the best solution for your situation, these three actions can help you decide.
1. Compare your options. Look at the interest rates and terms for HELOCs versus personal loans, credit cards, or even borrowing from your emergency fund if you have one. Calculate the total cost over time, along with the monthly payment. We offer a Home Equity Line of Credit payment calculator to help make the math easy.
2. Figure out how much equity you have. Lenders often require you to maintain at least 20% equity (the portion of your home you own outright) in your home after taking out a HELOC. To find your available equity, take your home's current value, subtract what you owe on your mortgage, and multiply by 0.80 (most lenders let you borrow up to 80% of your equity). You can also calculate the equity in your home by using our online calculator.
3. Review your budget. Can you afford the payments during both the draw period and the repayment phase? Factor in that most HELOC rates are variable and can change your payment over time.
If you have questions about whether a HELOC or another financial solution is the best fit, contact us to explore your options. HawaiiUSA is here to help support your financial goals.
