If you're researching ways to fund your next big project, you may have encountered lenders who offer a home equity line of credit (or HELOC). It's a unique type of loan that allows you to borrow money against the equity you have in your home. Since they are backed by collateral, homeowners can usually find HELOCs with better rates than personal credit lines and loans.
But like any time you borrow money, a home equity loan should be used wisely. We spoke with Alex Rodriguez, Amplify Credit Union's Real Estate Loan Agent Supervisor, for insight on the best ways to use a HELOC.
The 5 Best Ways to Use a HELOC
There are many ways that a homeowner may choose to access the equity in their home. According to Rodriguez, however, these are some of the most common usages of HELOCs by Amplify members.
Home improvement projects
Large projects like kitchen and bathroom renovations, HVAC unit replacements, and the installation of eco-friendly features require hefty chunks of change. Fortunately, home improvements and upgrades are a great way to use a home equity line of credit.
The best part is that these improvements often increase the value of your home. In best-case scenarios, the value they generate exceeds the amount you put into it. Before doing home renovations, do a little research to see what kinds of projects retain their value. This may help you effectively market your home when it comes time to sell.
If you have expensive credit card debt or high-interest loans, a HELOC can be used to pay off those bills.
Of course, if you continue an old habit of charging more than you can afford to pay back, consolidating will not help your situation. In this case, consolidation will only drive you farther in debt. Before you take out a line of credit, ensure that you are committed to getting to the root of the problem.
Paying off your mortgage
For those who still owe on their home mortgage, a home equity line of credit can help pay it off. For this refinancing to make sense financially, the interest rate on your line of credit needs to be lower than that of your mortgage. You'll pay less in interest on the remaining balance, potentially saving you thousands.
If you or your child are going off to college to earn a degree, a HELOC can help pay off tuition and other school expenses. Having an open line of credit comes in handy since paying for education is a recurring expense. Instead of paying interest on a lump sum of money the second you get it, you'll be paying for what you use, as you use it. The rates are also often cheaper than what you can find with unsecured student loans.
Medical expenses and emergency funds
If you find yourself in a pickle and don't have an emergency fund to fall back on, a home equity line of credit can a godsend. Though it may be challenging to get one quickly once the crisis arises, those who already have an existing credit line can use the funds for things like major car repairs or pricey doctors' visits. Using your line of credit is almost always better than risky alternatives like payday loans.
How to Get the Most Out of Your Home Equity Line of Credit
One key to getting the most out of your HELOC is to take out the most significant line that you can. "My suggestion is to take the maximum amount since this transaction is a revolving account and is reported to the credit bureaus as an available credit tradeline," Rodriguez advises.
It's better that you don't utilize the whole HELOC amount unless it's necessary.”
Of course, there is a difference between the amount you borrow and the amount you spend. It's better that you don't utilize the whole amount unless it's necessary. "Utilization benefits you and your credit score," Rodriguez notes. This is because credit utilization is a factor in how the credit bureaus calculate your credit score.
Credit utilization is simply the ratio of your credit balance to the limit on a revolving line of credit. "For example, if you only need $50,000 for your home improvement and have a HELOC with an available $100,000 credit limit," Rodriguez explains, "your utilization of credit would be 50%, which is a lot better then 100%. This could potentially improve your credit score."
According to Experian, one of the three major credit bureaus, it's best to keep your credit utilization rate under 30%. Don't forget to include any other revolving accounts you have open - such as a credit card - when doing your calculations.
The Cons of a Home Equity Line of Credit
Though there are many great ways to use your home equity line of credit, not all terms will be right for your financial situation.
"Interest rates on HELOCs are variable, which means the interest rate may rise," Rodriguez says. "It's not a fixed rate." This designation means that your interest rates may increase over time, costing you more than you planned.
Another downside is that it is easy to fall into a debt cycle similar to a credit card. "There's also the low-payment temptation," Rodriguez warns. "A HELOC has a very attractive feature— during the draw, your minimum monthly payment needs to only cover your interest charges."
Be sure that you fully understand your loan terms and what a fluctuating rate can do to your monthly payment. And to avoid racking up more debt than necessary, make an effort to pay more than the minimum balance every month.
Like any other type of loan, a home equity line of credit only makes financial sense if you use it responsibly.
A home equity line of credit is a useful loan that is great for things like home improvements, refinancing, debt consolidation, and paying for education. Use it wisely, and you can accomplish things that will ultimately bring you in more money or save you thousands in the long run.