Before we can even decide if you should use a HELOC, you need to understand what it really is.
Home equity lines of credit (HELOC) allow you to borrow against the equity you have in your house. The best part about a HELOC is that it differs from a regular loan where you start paying interest on the balance right away. Let’s say you get approved for an $80,000 HELOC, this means you have a line of credit for $80,000 that can be drawn upon whenever you want. And the best part about is that you don’t start paying interest on anything until you draw upon this line of credit. It really is a nice little tool to leverage cash for different reasons.
However, you do have to have enough equity in your home to be able to be approved for a HELOC. Typically, you can take out a HELOC if you have above 20% equity in your home (equity is how much you own) – and the amount you can borrow would equal the amount you have above that 20%. As of now, Bankrate.com says the average interest rate on a HELOC is just above 5%. This is way better than a credit card or most other loans.
HELOC’s have different term lengths for paying them off and the interest rate is variable. Since it is variable, you run the risk of the interest rate going up over the long term, which is why I typically only recommend people using them for short term goals. You probably wouldn’t want to use one for a project that is going to take 20 years to pay off. The shorter term, the better.
When Does It Make Sense To Use A HELOC?
Let’s first talk about a great recent example of when I helped a client use a HELOC recently. This person had some large unexpected expenses occur a year ago that he put on a credit card at a 25% interest rate. His emergency fund only had about $10,000 in it, so it would not cover the full amount from the cash he has. He has some investments, but we don’t want to have to sell them, pay taxes, etc. to help pay for this. We want to leave them compounding for as long as we can. So we ended up deciding to use a HELOC at 5% to pay off his credit card debt at 25%. That is a huge savings on interest! Then we will just pay the HELOC off over the next 3 years to get rid of it quickly. This is a great example of a time to use a HELOC where you save a lot of money on interest.
Here are some other good times to use HELOC:
- To pay off any other debt that has an interest rate significantly higher than the HELOC
- To help fund the down payment of a new house
- To fund a housing project
- Financial Emergencies
Here are some bad ways to use a HELOC:
- To buy a car
- To buy any depreciating asset that you don’t need
HELOC’s are a useful tool to leverage the equity you have in a home, you just don’t want to start using them as an ATM whenever you want to buy something new.
When Should You Get A HELOC?
The quality of a HELOC depends on where you get it from. Some banks have significantly better interest rates, lower fees, etc. So the best time to get one, is before you need one. This allows you to shop around and compare different ones when you have the time available now. If you wait and are in a pinch, then you may not get to explore all your options and end up with not the best option. I typically tell people to just get approved for one now. It won’t hurt you if you never use it since the interest only occurs when you draw from it.
HELOC’s are a great tool when used properly! If you are a homeowner, this is definitely something you should be thinking about using in the future!
Thanks for reading! If HELOC’s seem to be something you are interested in and you need help with it, reach out. At AllStreet Wealth, we help our client assess all their options and figure out what is best for them!
Disclaimer: Nothing on this blog should be considered advice, or recommendations. If you have questions pertaining your individual situation you should consult your financial advisor. For all of the disclaimers, please see my disclaimer page.