Editorial IndependenciaWe want to help you make more informed decisions. Some clearly marked links on this page may take you to a partner website and may earn us a referral fee. For more information, see How we make money.
Even with the variety of financing options available today, homeowners have a unique advantage.
After you build enough equity in your home, you may be able to borrow against that amount through a home equity line of credit, or HELOC. Because HELOCs are secured by an asset (your home), they’re one of the most popular ways to borrow at lower interest rates, especially when you’re facing high costs for necessities like home improvements, college tuition, or debt consolidation. debts.
HELOCs are generally easy to obtain if you already have at least 15% to 20% equity in your home, and they may offer certain benefits, such as lower interest rates or longer loan terms, compared to other forms of financing, such as personal loans and credit cards. A type of revolving line of credit, a HELOC can also offer interest-only payments. And unlike an installment loan, borrowers can access their HELOC over and over again while paying off the balance (just like a credit card).
But before you take out what’s often colloquially known as a “second mortgage,” you’ll want to consider exactly how you plan to use a HELOC, as well as look at some alternatives that won’t put your home in jeopardy.
In this article, we will share six ideas on what a HELOC can be used for. In addition, we will provide you with three alternatives if you decide that a HELOC is not right for you.
- 1 Is a home equity line of credit a good idea for me?
- 2 Pros and cons of a HELOC
- 3 5 Common Uses for a HELOC
- 4 Alternatives to a Home Equity Line of Credit (HELOC)
Is a home equity line of credit a good idea for me?
HELOCs can provide homeowners with much-needed, flexible access to credit on an ongoing and revolving basis, if they can qualify. Once established, these lines of credit can serve as a useful back-up reserve of funds for projects that exceed your daily budget.
That said, HELOCs have fees and terms that every borrower should be aware of. Depending on the size of your HELOC, you may encounter closing costs to apply for and use your line of credit. These charges may include the costs of originating, underwriting, closing, and recording your loan. In addition, some HELOCs have initial blackout periods, lasting from a couple of months to a few years, during which you may be charged a prepayment penalty or early termination fee for paying off the loan or closing the line of credit. Different lenders may charge different fees, and some may even waive certain fees entirely, so be sure to ask your lender exactly how much you’ll pay.
Be sure to shop around multiple lenders to ensure you get the best deal. Don’t just look at rates, either; be sure to also look at the fees and the total cost of the loan.
Banks commonly advertise “no fee” HELOCs that require no cash to open and come with no prepayment penalties. Your bank may offer specific discounts based on your existing relationship and account balances. Also, some lenders offer introductory pricing that makes the rate even lower for the first few months your HELOC is open. Do your research thoroughly before you apply, and remember that even a “no-fee” HELOC will at least charge interest.
Pros and cons of a HELOC
In particular, HELOCs are known for offering interest-only payments, making them an even more attractive option for flexible financing. However, every benefit comes with a caveat, according to Casey Fleming, mortgage consultant for Fairway Independent Mortgage Company.
“Many people only pay the minimum payment on their HELOC,” says Fleming. “They end up paying for that shopping spree for the next 25 years. Only go this route if you have a plan to pay off the balance quickly,” he says.
Here are some additional pros and cons of taking out a HELOC:
May offer interest-only payments for the first year(s)
It can allow borrowers to access revolving credit worth up to a certain percentage of their home’s value (typically 85%).
Interest may be tax deductible if the funds are used to improve the value of your home
can be used as you like
Interest payments alone require additional discipline and can encourage spending beyond your means.
May charge closing costs, like on a primary mortgage (but not always)
You generally need at least 15% to 20% equity in your home to qualify
Failure to pay could result in foreclosure on your home
5 Common Uses for a HELOC
You don’t have to use a HELOC just for household-related expenses.
If you’re wondering what else you can use a HELOC for, here are some options:
HELOCs are “especially good for home improvement projects when you don’t know what the final cost will be,” says Michelle Lambright Black, a credit expert and personal finance writer. Construction projects are notorious for going over budget or changing scope midway, and you don’t want to run out of money before your project is complete.
Many people use HELOCs to consolidate high-interest debt and lower their monthly payments. This strategy can work, as long as you have a final plan to pay off the debt.
According to Lambright Black, a “hidden benefit” of using a HELOC to pay off credit card debt is that it can improve your credit score. Credit bureaus don’t factor HELOC utilization into credit scoring, so moving credit card debt to HELOC could lower your reported credit utilization ratio. Such a boost to your score could help you qualify for better rates and terms on other loans.
Purchase of another property
If you want to buy a vacation home or rental property, a HELOC can simplify the process. Assuming your home’s equity is comparable to the cost of another, using a HELOC instead of a traditional mortgage could help you avoid the typical 30- to 60-day underwriting process.
Assuming you can afford to “retire” your HELOC, your offer on a new home could be considered stronger than that of competing buyers because it would not rely on bank financing.
An emergency backup fund
The general rule of thumb is that you should have an emergency fund that covers three to six months of expenses. While that’s ideal, the reality is that most families don’t have much in store for emergencies. A HELOC can serve as a backup to your emergency fund in case something unexpected comes up.
Cover business expenses
Business owners can often use a HELOC with lower rates than those charged on a small business loan. Also, a HELOC does not require your business to be open for two years before being approved, as most small business loans do. The HELOC can be used to start a new business, cover ongoing expenses, or expand an existing business. But be aware of the risks associated with investing in a business using your home as collateral.
Alternatives to a Home Equity Line of Credit (HELOC)
If you need financing but don’t think a HELOC might be the best option for you, here are some alternative ways to get the financing you need:
Refinancing with cash out
With interest rates near record lows, doing a cash-out refinance on your existing mortgage can lock in low rates for the next 15 to 30 years. According to Fleming, a cash-out refinance “is a good idea if your current mortgage doesn’t have a low interest rate.” And, since a traditional mortgage payment includes principal and interest, your balance goes down with each payment. By comparison, payments from an interest-only HELOC during the draw period would not reduce your principal balance.
Credit card promotion 0% APR
Many credit cards offer an interest-free promotional period when you first open your account. These 0% APR promotions can be used for purchases, balance transfers, or sometimes both. Some of these promotions can last up to 18 months or more. While some banks charge a 3% to 5% balance transfer fee, they typically don’t charge a fee for purchase promotions.
“These deals are a good idea if you can pay off the balance before the promotion expires,” says Lambright Black.
Personal loan or line of credit
Although personal loans or personal lines of credit may have a higher interest rate, they can usually be opened very quickly. In some cases, borrowers can see cash in the bank account on the same day as their application.
Meanwhile, most HELOCs require an evaluation and underwriting can take a few weeks before the application is approved. Not to mention, HELOCs sometimes require you to keep the line of credit open for a minimum of a couple of years. So if you need quick cash for a specific purpose (and plan to pay it off quickly), personal loans may be preferable in this scenario.