The Ultimate Guide to Using a HELOC Wisely

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How Does a HELOC Work?

A home equity line of credit (HELOC) is a revolving line of credit that allows you to borrow against up to 85% of your home’s equity. This equity is the difference between your home’s value and your remaining mortgage balance. The HELOC repayment process is divided into two phases: the draw period, typically lasting 10 years, and the repayment period, often 20 years. During the draw period, you make interest-only payments on the money you use. Once the draw period ends, you start repaying the balance in full, which can significantly increase your payments. It’s crucial to plan ahead, as failure to make payments can put you at risk of foreclosure. Most HELOCs have variable interest rates and a rate cap, with closing costs averaging between 2% to 5%.

Best 5 Ways to Use a HELOC

HELOCs offer high lending limits and flexibility, generally with lower interest rates than other borrowing options. However, they require using your home as collateral. Here are five of the best ways to use a HELOC:

1. Improve Your Home

HELOCs provide flexible funding for home improvement projects, especially those that roll out in stages or have hidden costs. Additionally, if you itemize your deductions, the interest on your HELOC may be tax-deductible when used to “buy, build, or substantially improve” your home, potentially lowering your net costs with tax savings.

2. Do Major Home Repairs

While routine fixes should be covered by your home maintenance budget or emergency fund, a HELOC can help pay for major repairs like a new roof. If these repairs add to your home’s value, the interest on your HELOC may be tax-deductible. Consult a tax professional to ensure your expenses qualify.

3. Get Ready to Sell

If your home needs improvements before selling, a HELOC can cover costs like new landscaping or HVAC upgrades, helping you fetch top dollar. You may even be able to pay off your HELOC using proceeds from the sale.

4. Consolidate or Pay Off Debt

Using a low-interest HELOC to pay off high-interest credit card debt can save you money on interest charges and consolidate bills. This can also improve your credit score by enhancing your credit utilization ratio. However, ensure you have a solid plan to pay off the debt without incurring new debt, as falling behind on payments could put your home at risk.

5. Bolster Your Emergency Fund

Keeping a line of credit in reserve provides an additional defense during financial crises. Whether facing unexpected expenses or unemployment, a HELOC can offer a ready supply of cash if your emergency fund falls short.

When Not to Use a HELOC

While a HELOC can fund almost anything, there are times when it may not be the best option. Here are a few scenarios where you might want to consider other financing options:

Discretionary Spending

Using a HELOC for regular expenses or big-ticket items like weddings and vacations isn’t a good long-term strategy. It moves you away from owning your home and puts it at risk.

Buying a Car

Even with high-interest rates, you can likely find a car loan with an APR comparable to a HELOC if you have good credit. More importantly, the loan will be secured by your car, not your home.

Paying for College

For college tuition and expenses, consider student loans, which often have lower interest rates and offer protections like deferment, forbearance, forgiveness, or income-based repayment plans. Scholarships, budget-friendly schools, or community colleges can also help save money.

Covering Medical Debt

Before using a HELOC for medical debt, contact your healthcare provider and insurance company to ensure you’ve received all entitled coverage. You may also negotiate your bill, set up a payment plan, or qualify for financial assistance.

Starting a Business

New businesses are risky, and failure to repay a HELOC could put your home at risk. Consider SBA or business loans, crowdfunding, investors, or credit cards instead.

Investing

Using a HELOC for investments or investment properties can be risky. If your investments fail, you could lose both your investment and your home.

Is a HELOC a Good Idea?

A HELOC can be a great choice for home repairs, renovations, or consolidating high-interest debt. It can also serve as an emergency funding resource. However, because it taps into your home’s equity, it’s not always the best option for large expenses like weddings, cars, college, or starting a business. In these cases, other loans may be more suitable and keep your home equity intact.

Alternatives to HELOCs

If you need to finance a major purchase, create a line of credit, or refinance debt, consider these alternatives:

Home Equity Loan

Home equity loans are installment loans using your home’s equity as collateral. They offer a fixed loan amount and fixed APR, providing predictability.

Cash-Out Home Refinance

Refinance to a larger loan and receive the difference in cash. This is ideal when interest rates are low. However, it resets your mortgage clock, extending the repayment period.

Personal Loan

Personal loans offer fixed APRs and require no collateral. While rates may be higher than a HELOC, your home isn’t used as security. Loans are available for up to $100,000.

Personal Line of Credit

If you have good credit, your bank or credit union may offer an unsecured personal line of credit for debt repayment or large expenses. Unlike HELOCs, these count toward credit utilization in credit score calculations.

Balance Transfer Credit Card

Refinance high-interest credit card debt with a balance transfer card offering a low or 0% introductory rate. Pay off the balance during the promotional period to avoid higher interest rates later. Good credit is required to qualify.

Reverse Mortgage

If your home is paid off or nearly paid off, a reverse mortgage provides regular payments using your home’s equity as collateral. You don’t make payments on a reverse mortgage; instead, you pay off the balance when you sell your home. Homeowners must be 62 or older to qualify.

The Bottom Line

HELOCs offer benefits like lower interest rates, funding flexibility, and potential tax deductions. However, using your home as collateral is serious. If your income fluctuates or you’re at risk of not repaying the loan, proceed with caution. To qualify for a HELOC, you’ll need a good credit score and significant home equity. Checking your credit report and score can help you decide if a HELOC is right for you.

For any mortgage service needs, call O1ne Mortgage at 213-732-3074. We’re here to help you make the best financial decisions for your home.

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