How to use a Home Equity Line of Credit

Can you use a HELOC for anything? Technically, yes – there are no rules about how to use home equity, but there are suggested best practices to put the funds to your advantage and reduce the risk that comes with borrowing against your home. In this article, we’ll explore some of the best ways to use home equity and riskier situations that warrant more caution.

How a HELOC works

A home equity line of credit (HELOC) is a revolving line of credit based on the equity you have in your home. Similar to a credit card, your lender sets a limit and you can access the funds as you need them during the draw period, often up to 10 years. You only pay interest on the funds that you withdraw.

• A HELOC typically has low closing costs and a low introductory interest rate.
• During the draw period, you are typically able to access the cash whenever you want it.
• When you reach the repayment period, you begin making regular monthly payments with principal and interest, which may be variable based on current market trends. Though you’ll want to double check the terms of your HELOC to determine your exact repayment terms.

Real talk: Are HELOCs bad?

On the surface, a home equity line of credit is not good or bad. A HELOC can be a great tool when used thoughtfully in the right situations. But, like a home equity loan, your property is used as collateral to access your equity. In extreme circumstances, missing payments and defaulting on the loan can lead to losing your home. That’s why you want to weigh the rewards and risks of a HELOC for your desired use.

Best ways to use a HELOC

“Best” is a relative term, but consider this: If your spouse suddenly got a job transfer across the country and you had to sell your house (and pay back the HELOC), did your use of the funds put you in a better financial position? Experts often suggest the best use of home equity is to add value to your property. A HELOC can also be a tool to improve your financial situation – especially during an emergency.

Add value to your home

Fun fact: If you use your HELOC to “buy, build, or substantially improve” your property, the interest may be tax deductible. Consult a tax adviser for further information regarding the deductibility of interest and charges. How can you use equity to build equity? Here are some ways to consider making value-adding improvements to your home.

• Make strategic home improvements. Fresh landscaping, kitchen cabinets and countertops, bathroom fixtures, and flooring are included in the top 10 home improvements to increase your property’s resale value. Just be sure to do your research to ensure the changes are worth the cost.
• Increase energy efficiency. New appliances, thicker windows, low-flow toilets, and solar panels don’t just reduce your carbon footprint. They can help you reduce monthly energy bills and help optimize your home’s future resale value. 
• Add additional space. Could your family use a little more elbow room? Would another bedroom or a larger family room be more appealing to a future buyer or allow you to create rental income? Adding square footage to your home can increase its value when done thoughtfully.

Improve your finances

How could some extra cash put you in a better financial position? It depends on your situation as well as your strategy for paying back the loan. Here are some possibilities.

• Pay off high-interest debt. Credit cards, student loans, and personal loans typically have higher interest rates than a HELOC. Keep in mind: “Pay off” doesn’t mean the debt is erased, it’s simply transferred to the new loan. A best practice is to ignore the HELOC’s low minimum payments and pay it off as quickly as possible.
• Consolidate multiple debt payments. If you don’t have enough equity to pay off those high-interest loans, debt consolidation can help streamline payments, save money, or spread payments out over a longer period of time. Again, this technique is an exchange of loan types, and the new one must still be paid back. 
• Fund emergencies. Many experts recommend setting aside six months’ worth of expenses in an emergency fund to cover unexpected costs from life’s curveballs. If finances are tight, your home equity can help you build a cushion or access it immediately if emergency strikes. 

Riskier ways to use a HELOC

What should you not use a HELOC for? Like so many personal finance questions, the answer is not black and white. People have found how to use home equity to build wealth in creative ways, but success is not always replicable or guaranteed. The following uses may benefit from additional caution.

Purchase depreciating assets

Can you use home equity to buy a car or remodel a Sprinter to fuel your #vanlife dreams? Consider the following before springing for a purchase.

• Buy a new vehicle. Take heed before using home equity to buy a car or that open-top Jeep that’s been on your vision board for years. A HELOC can help you get on your feet if a vehicle breaks down, but a purchase outside your means can lead to financial hardship down the road. A car loan, which uses the vehicle as collateral, may be a better option.
• Get a boat, RV, or UTV. Casting a line on the water. Camping under the stars. No doubt the great outdoors can enhance our quality of life, but many popular products are best viewed as “toys” rather than an investment. 

Fund volatile investments

Can you use a HELOC to buy a house or as a down payment on an investment property? How about putting cash into the market? You can, but ensure you know the potential risks first.

• Purchase real estate. It’s possible to put the equity in your home to work by investing in a second home or other real estate, but it doesn’t come without risk. Fluctuating property values tend to make this investment a long game, which may not serve you well when it comes time to pay back a HELOC. Do your due diligence before using home equity for a down payment.
• Invest in the stock market. There’s potential for profit by using a HELOC to invest in the stock market, but stocks are known to go up and down in value. If your home value decreases at the same time the market is down, you could be left with negative equity.

Pay for expenses you could save for

We get it: Sometimes a quick boost of cash flow is helpful in a pinch. But if something doesn’t fit in your budget, it may be wise to save or consider alternative solutions. 

• Book a vacation. Planning a holiday with home equity funds can be an option, but the typical rule of thumb for vacation expenses is to save up for them rather than use debt. You’ll likely even relax more knowing the trip is not setting you back financially. 
• Fund college. It’s not to say you can’t use equity to pay for educational expenses, but it comes back to risk vs. reward. Are you comfortable putting your house on the line to pay for college? Or are 529 plans, grants, and student loans safer options?
• Start a business. Even the best business ideas can go awry through no fault of your own. Having your house on the line may create undue stress as you’re getting your venture off the ground. Consider starting small and cash-flowing what you can, or explore business loan options instead.

HELOC wisely

Again: There are no HELOC use restrictions and “good” and “bad” uses really come down to your situation and how you plan to pay back the debt. A renovation doesn’t always lead to a return on investment, and a second home purchased with a HELOC may very well fast forward your financial goals. When thinking through what to do with home equity, we recommend:

1. Identifying your needs
2. Considering all your options
3. Making a repayment plan (and sticking to it)