What can you use a HELOC for?
When you take out a HELOC, it opens a line of credit tied to your home equity. You can tap that credit line, up to your limit, to access cash on an as-needed basis (much like how you’d use a credit card).
HELOCs don’t have restrictions, so you can use the funds you borrow for any purpose — from debt consolidation to investing or buying additional properties. Even so, some HELOC uses are smarter than others. If you’re considering getting a HELOC, here are some of the best ways you can use the funds.
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Why you should use a HELOC carefully
The important thing to remember about a HELOC is that the money you borrow is tied to your home. This makes it a relatively cheap way to access cash. But it also means you’re going to be paying the loan off for a long time. And, if you can’t repay the HELOC for some reason, you could risk foreclosure.
Because a HELOC or home equity loan is a long-term mortgage, it’s generally best to invest the money in something that will provide an equally long-term return on investment. On the flip side, it’s often not financially “wise” to spend HELOC funds on one-time expenses that won’t generate any return.
With that said, here are six of the best ways you can use a HELOC to your advantage.
Best ways to use a HELOC
1. Home improvements
Since a HELOC can free up large sums of money, some borrowers use the funds to complete home improvements or renovations. For example, you might tap a HELOC to do a kitchen or bathroom remodel, add a room or accessory dwelling unit, or install new roofs, windows, or doors. Using a HELOC to improve your home can significantly increase its value; as such, these types of projects may offer the highest rate of return.
2. Emergency funds
Ideally, everyone should have 3 to 6 months’ worth of living expenses saved in an emergency fund. If you don’t have that much cash in your savings account, a HELOC can create an additional financial cushion in case of emergencies. Keep in mind that once you open a HELOC, you don’t have to borrow from it. You can simply keep the credit line available should you need the money later on.
For instance, you might tap your HELOC after a job loss, an unexpected medical expense, or if you’re unable to work due to an illness. Some people use a credit card in these situations, but the interest rate on a HELOC is often far lower.
3. Paying off debt
Debt consolidation can be another smart use for a HELOC. You might use the funds to pay off high-interest credit card debts or expensive personal loans. However, using this account for debt consolidation only makes sense when the interest rate on your existing debt is higher than the interest rate on the HELOC.
It’s also important to know the potential danger of using your home equity to pay off debt. Some people rack up more debt after using a HELOC to pay off credit cards. Therefore, only use this strategy if you’re sure you can manage credit responsibly in the future.
4. Buying a new house
Buying an investment property or vacation home typically requires a larger down payment — sometimes as much as 20%-25%. If you don’t want to use your personal savings, you can borrow from your current home’s equity and use these funds for the purchase. If you have enough equity available in your primary home, you may even be able to purchase a second home with cash.
5. Starting a business
Starting a business is expensive and often requires working capital (business license, insurance, supplies, equipment, marketing, etc). Many new business owners apply for a business loan or a business credit card to cover these costs. However, HELOCs typically have lower rates and can provide more funding.
A HELOC can also function as a safety net. You don’t have to use the money now, but you may choose to tap the credit line later on if your business is temporarily short on cash flow during its early stages.
6. Living in retirement
HELOCs can also improve your quality of life in retirement. Are you thinking about starting a small business or buying an income-generating property? A home equity line of credit can give you access to low-cost funding.
In addition, this account can provide funds to make a home more accessible. It can pay for modifications like building an accessibility ramp, installing a stair lifter, and creating a handicap-accessible bathroom.
How not to use a HELOC
While there are many good uses for a HELOC, they’re also some “not-so-good” uses. Most experts don’t recommend spending your equity on one-time expenses that won’t improve your overall financial health. For example, it’s usually not the best idea to use a HELOC for the following:
1. Buying a car
Since most cars only depreciate in value, it doesn’t make sense to take out a long-term mortgage for this purchase. In most cases, auto loans can offer better rates and shorter loan terms. Plus, if you default on a home equity line of credit, the lender doesn’t take your car — it takes your house.
2. Paying for a vacation
Even though some people use a HELOC to fund a dream vacation, many financial experts advise against getting into debt for this purpose. You’ll be paying off that one-time adventure over many years — with interest — which means your vacation will cost a lot more in the long run. A better solution is to create a budget and save money over time.
3. Hosting an event
Likewise, mortgage pros don’t recommend using a home equity line of credit to pay for an event or party, including weddings.
Understandably, wedding costs can add up quickly, and using a HELOC is often cheaper than using a credit card. But tapping your equity for this occasion is risky. You might spend more than you can actually afford, especially if your HELOC has a large credit limit. Plus, a wedding is a one-day event that doesn’t offer a long-term return.
4. Paying for college education
Some people believe paying college tuition is a good use of HELOC funds. And indeed, higher education can provide great returns in the form of better job prospects and higher salaries later on. But a HELOC likely isn’t the cheapest way to pay for your college education; federal student loans are often better because they typically have lower rates compared to a second mortgage.
Additionally, federal loans offer hardship provisions such as forbearance, deferment, and income-based repayment plans. These can provide affordable solutions or even debt relief when you’re unable to make loan payments. By contrast, not paying a HELOC could lead to foreclosure.
5. Other short-term costs without long-term returns
These aren’t the only unwise uses for a HELOC. Before applying, consider how you’ll use funds and evaluate the long-term return. Other risky uses for a home equity line of credit can include investing in the stock market, buying electronics, shopping sprees, and using funds for improvements that don’t increase the value of your home.
If you’re unsure whether a HELOC is the right choice for you, connect with a mortgage lender. Your loan officer can help you evaluate your needs and loan options to find the best solution.
How HELOC funds work
A HELOC is a revolving line of credit similar to a credit card. Your equity serves as collateral for the line, and you can withdraw as much as you need, up to your credit limit.
These accounts typically have a draw period of 10 to 15 years and a repayment period of up to 20 years. During the draw period, you can use the credit line, repay it, and use it again while making interest-only payments. During the repayment period, you can no longer borrow from your HELOC and must repay any outstanding balance on a set schedule.
Maximum HELOC amounts vary depending on a borrower’s home value, credit history, income, and debts. Most lenders allow borrowers to withdraw up to 85% of their home’s equity.
Since HELOCs work like credit cards, you pay back only what you spend. But be mindful that most HELOCs have variable interest rates, so your payment can change over time depending on the current interest market.
The good news is that most states cap rate increases on HELOCs. Therefore, your rate might never exceed a certain percentage. Still, it’s important to consider the worst-case scenario before getting a home equity line of credit.
How to use a HELOC: FAQ
Lenders don’t impose restrictions on how you can use your HELOC funds. You’re free to use the money for anything you like. But since your home acts as collateral for the loan, some uses are better than others. These include debt consolidation, home improvements, business expenses, or creating an emergency fund. Less-wise uses for a HELOC can include buying a car, paying for college, paying for a wedding, or taking a vacation.
HELOCs do have some disadvantages. Keep in mind that you’re reducing your home’s equity and using the property as collateral for the line of credit. So failing to make monthly payments can put your home at risk of foreclosure. There’s also the risk of overspending and borrowing more than you can afford, and monthly payments can increase over time due to variable rates.
A HELOC lets you tap your equity and get cash as needed from the value of your home. You can withdraw cash from the home equity line up to your credit limit throughout its draw period, which usually lasts 10 or 15 years.
Yes, you can open a HELOC and never use any of it. This is a revolving credit account like a credit card, so you’ll pay back only what you borrow. Some people open a line of credit as an emergency fund, just in case they need access to cash later on. Some lenders do charge an inactivity fee on HELOCs, though, so ask about this before you apply.
Since a HELOC is a line of credit, you repay only what you choose to borrow. During the draw period — which is usually 10 years — many lenders require interest-only payments on what you’ve withdrawn from the credit line. After the draw period, you’ll repay the remaining balance over 10 to 20 years.
Lenders provide multiple ways to access money in a HELOC. Depending on your bank, these options can include using a HELOC ATM card to withdraw cash; scheduling online transfers from your line of credit to your checking account; or writing yourself a check using a checkbook that’s linked to your HELOC.
How to get a HELOC
If you’re ready to apply for a HELOC, the next step is to reach out to a mortgage lender for a rate quote. A wide variety of banks, credit unions, online lenders, and mortgage brokers can offer HELOCs.
You’ll submit an application and income documentation like tax returns, W2s, and paycheck stubs. Your lender might also request a copy of your homeowner’s insurance, a mortgage statement, and a tax bill.
To determine how much you can borrow, the lender will review your income and credit history and likely order a home appraisal. On average, it takes between 30 and 60 days to close a HELOC.
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