Expanded Lesson
6 min read
What Is a Home Equity Line of Credit (HELOC) and What Can You Use It For?
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Home equity lines of credit (HELOC) have a wide variety of uses. Read this article to learn more about how they work and how they can help you tackle your next project.
LESSON CONTENTS
Key Points
- HELOCs can be a source of cash that can help with major purchases, debt repayment and renovations.
- A HELOC is a revolving source of funds that can be accessed as the need arises.
- HELOCs are secured loans against the equity in your home, so they may have lower rates than non-secured loans.
How Does a HELOC Work?
A home equity line of credit isn’t the same as a traditional loan. The lender will issue you a line of credit, which you can use as you see fit. The lender will usually loan up to 80% or 90% of your home’s equity.
To calculate your available equity, divide how much you still owe on your mortgage by the current market value of your home. For example, if your home is worth $300,000 and you still owe $150,000 on the property, your loan to value would be 50%, or $150,000, considering you’ve already paid off half the mortgage. That means you may have up to $100,000 in equity available for a HELOC.
Just like a credit card, you have to pay interest on the money you borrow from the HELOC account. For example, if you qualify for up to $100,000 in the form of a HELOC but you only decide to spend $50,000, you don’t have to pay interest on the rest of the balance as long as the remaining credit limit isn’t advanced. This type of HELOC is the more flexible financing option.
Home equity lines of credit usually come with variable or fixed interest rate options. A variable rate means the interest rate could fluctuate up or down over the term of the loan. HELOCs may also provide an option of making interest-only payments during the draw period. This means you can pay off any interest that’s accrued on the line of credit.
What Can You Use It For?
Home projects
Whether it’s something that’s been on your renovation to-do list for years or creating that perfect outdoor space in time to enjoy the nice weather, a HELOC is a great option that can help you tackle your next home project.
It’s been estimated that the average cost to remodel a house is around $47,000 (costs will vary by location). If you’re working on a larger project, it may be easier to qualify for a HELOC than other loan products that are not secured or do not require collateral. Another benefit of using a HELOC for a home project is that it can provide a flexible source of cash. This means that you don’t have to worry if an unexpected cost arises or the project takes longer than originally thought.
Renovations and remodeling can have financial and aesthetic benefits. Making upgrades to your home can raise the value and make it more attractive to potential renters and buyers. However, some renovations are more valuable than others. Make sure to research the cost recovery of the upgrade to get the most bang for your buck.
Paying for college
Whether you’re going back to school or sending your child off to college, higher education can have a significant price tag. Knowing how you’re going to pay for tuition is an important financial milestone to plan for. Many college students rely on federal student aid to help pay for tuition, but some may not have access to specific funds.
Need-based financial aid can give students access to direct subsidized loans, federal work-study programs and Pell grants. However, if the Expected Family Contribution (formula based on your family’s untaxed income, assets and benefits [like unemployment or Social Security]) on the student’s FAFSA is too high, they may not be eligible for need-based financial aid.
Depending on your financial circumstance, a HELOC may be a viable option to pay for some or all of the cost of college. HELOCs generally have lower interest rates than private student loans so you may be able to save on interest payments in the long run. However, HELOCs don’t come with the other benefits associated with non-need-based federal student loans (like direct unsubsidized loans) such as grace periods, income-based payment plans, forbearance and loan forgiveness.
Before using home equity to finance college costs, be sure to research all of your options. Taking out home equity could be riskier; if you default on your loan, you could lose your home.
Consolidating debt
Credit card and other high-interest debt can hinder anyone’s financial progress. One strategy to help manage debt is debt consolidation. Debt consolidation involves consolidating multiple high-interest consumer loans (like multiple credit card balances) into one lower-interest loan. Consolidating debt has the benefit of helping you save money on interest payments and making it easier to keep track of your payments.
HELOCs can be a good debt consolidation tool because they have low interest rates and they may be easier to obtain than other non-secured lines of credit. If you’re thinking of using a HELOC to consolidate and pay down other forms of debt, make sure you have a solid debt payment strategy in place. The last thing you want to do is consolidate your loans, only to keep spending and get into more debt.
PLEASE NOTE: Remember that HELOCs are secured against the value of your home. Be careful about using it for everyday/non-essential items.
Putting a down payment on a rental/investment property
The popularity of real estate investing as a retirement strategy or passive income stream has been on the rise. One of the main questions of people who are first getting started in real estate investing is “what is the best way to get the initial funding to buy a property or finance deals?”
While there are many options to obtain funding to buy your first rental or investment property, a HELOC may have an additional benefit. In Colorado, the average single-family home is only on the market for 39 days before it’s sold (as of March 2021), which is a 26% drop from the average time-on-market last year. If numbers continue to drop, having a line of credit to act quickly on properties will be very important. If an opportunity arises, having quick access to cash through something like a HELOC can make the difference between getting the property you wanted or not.
Ready to put your home equity to work?
Apply for a HELOC or talk to a Lending Specialist.
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