Is a Home Equity Line of Credit for me?
You may be interested in borrowing money against your home’s equity—here’s what to consider:
Home equity is the difference between the appraised value of your home and the balance on your mortgage. If you have built up significant equity, you may be able to borrow a portion of it using a home equity line of credit (HELOC).
If you are approved for a home equity line of credit, a lender extends you a line of credit for a set number of years. You can borrow money up to your credit limit for the first period of the loan—typically 10 years—while you make at least the minimum monthly payments. When your borrowing period ends, you must repay the loan in full, usually over a 20-year period. An important benefit of a home equity line of credit is that its interest rate is usually much lower than other types of credit. However, you should consider the risk that if you default on your payments, the lender could foreclose on your home. Borrowing against home equity isn’t right for everyone and every situation: Make sure you understand both the benefits and potential risks.
Here are five ways homeowners commonly use HELOCs.
1. Improve and upgrade your home
Improving your home through additions, repairs and renovations may help you keep pace with your changing needs. Some home improvements, such as adding livable square footage or updating an outdated kitchen or bathroom, might also increase the property’s value. Energy-efficient upgrades can lower your utility bills and provide rebates or tax credits. Check the IRS website or consult with a tax advisor for more details.
Tip: Not all upgrades increase your home’s value. It’s especially important to think about their costs, how much you’re paying in interest and potential impact on your home’s worth if you’re using a home equity line of credit to pay for them.
2. Access lower interest rates on credit
A home equity line of credit may charge you a lower interest rate than other types of borrowing such as credit cards, car loans and private student loans. According to Bankrate.com, at the end of 2018 the average rate for a variable-rate HELOC was about 5.6 percent, while variable-rate credit cards offered an average interest rate of about 17.6 percent. Additionally, banks often offer introductory rates and discounts on home equity lines of credit. And unlike credit cards, the interest you pay may be tax-deductible if you use the loan to buy, build or substantially improve the home that secures the loan. It’s a good idea to consult your tax advisor regarding tax deductibility, as tax rules tend to change.
Tip: While interest rates on home equity lines of credit are generally lower than credit card rates, remember the HELOC is secured by your home, and if you don’t make your payments, you could lose your home.
3. Consolidate your debt
Since the interest rate on your home equity line of credit may be lower than those of your other loans, you might consider using it to consolidate your debt. Doing so could help simplify your payments and reduce your interest costs.
If you use a HELOC to consolidate debt, you may save on interest if you pay at least as much toward your new, lower-interest-rate loan each month as you paid toward the higher-rate debt. The relative benefits of using a home equity line of credit for debt consolidation depend on individual circumstances.
Tip: If you consolidate credit card debt using a home equity line of credit, you’re turning unsecured debt into secured debt, so you want to be confident you can afford the payments. Also, be careful not to run up new debt, such as on newly paid-off credit cards.
4. Help bridge the costs of higher education
If your children are heading to college—or if you’re contemplating going back to school—a home equity line of credit can help you manage the costs. You could borrow money through your HELOC to make tuition payments when they’re due and then pay the debt off over the set repayment period for your line of credit. Learn more about covering the cost of college.
Tip: It’s important to compare HELOC interest rates to student loan interest rates and repayment options. While lower interest rates are usually preferable, it’s a good idea to talk to a financial advisor about the best option for your situation.
5. Rethink expensive one-time purchases
Expensive discretionary purchases, such as vacations or an extravagant wedding, are generally not the best reasons to draw on your home equity. Remember that your collateral for your HELOC is the place where you live, your home. Be sure to carefully consider all of the options that might be available to you.
Before you apply for a HELOC, learn as much as you can about them so you can make more informed choices on how to reach your financial goals.
