If you purchased your home in 2020 (or sooner) you likely have a tremendous amount of equity in your home. Imagine having a flexible financial resource at your fingertips—one that allows you to tap into the equity you’ve built in your home. Enter the Home Equity Line of Credit (HELOC). In this blog, I’ll walk you through what a HELOC is, how it works, and why it might just be the game-changer you need for your financial journey. I’ve had this conversation recently with a few people so I decided to write a blog post about it. Use caution—if you are not extremely diligent in not over-using credit cards then a HELOC could be a good choice for you. But if you have a tendency to over-spend then this is not a good option for you! Know your limits!
What is a HELOC?
A Home Equity Line of Credit (HELOC) is a revolving line of credit that leverages the equity you’ve accrued in your home. Equity is the difference between your home’s current value and the remaining balance on your mortgage. Unlike a traditional loan, a HELOC offers you access to funds as needed, up to a predetermined credit limit.
Here’s an example:
A homeowner who purchased their property for $225,000 in 2019, with a current loan balance of $180,000 and a property currently appraised at $350,000, could potentially qualify for a HELOC with a limit of approximately $87k. Would this home owner HAVE to take out the maximum amount? No! That home owner could chose to have a HELOC max of any amount: 10k, 20k, 50k up to 87k. Does that mean the home owner took out a loan of $87k? Nope! Just like a credit card a HELOC gives you a maximum amount that you can spend at any given time. (please note this is just a very simplified example)
How Does a HELOC Work?
Think of a HELOC as a credit card—your home acts as collateral. Once approved, you’re free to borrow up to the credit limit during a specified “draw period,” usually around 10 years. During this time, you can borrow, repay, and borrow again, just like a credit card. The interest rate on a HELOC is typically variable, which means it can change based on market conditions. This is very important to understand! I tend to use my HELOC with a temporary use perspective. What do I mean?
Primarily because of the variable interest rate, the question arises: should HELOCs be used only temporarily, or can they serve a more long-term purpose? Let’s explore the dynamics of using a HELOC, whether as a short-term strategy or a sustainable financial solution.
The Temporary Use Perspective
- Home Improvements: Many homeowners initially turn to HELOCs for short-term projects like home improvements. These projects can add value to your property, allowing you to recoup the investment when you eventually sell.
- Emergency Funds: A HELOC can act as an accessible emergency fund. It’s there when you need it, providing a cushion to handle unforeseen expenses without draining your savings. This is my preferred reason for having a HELOC!
- Debt Consolidation: Short-term debt consolidation is another common use of a HELOC. By consolidating high-interest debts into a lower-interest HELOC, you can save on interest payments and potentially pay off debt faster. But make sure you understand the interest rate and that you have a payment plan ready to go!
- Investment Opportunities: Some investors leverage HELOCs to seize time-sensitive investment opportunities, with the intention of repaying the borrowed amount within a relatively short timeframe. This is my second reason for having a HELOC–I have a large amount of cash available for a down payment or potentially even paying without the need of a loan. Once I close on the property I can refinance—this would allow me to beat out any conventional buyers and offer a speedy close!
The Long-Term Approach
- Flexible Financial Resource: A HELOC’s flexible nature allows it to be used as an ongoing source of funds. If managed responsibly, it can provide you with a steady stream of financing for various needs over the years.
- Education Funding: Using a HELOC to fund education expenses can provide a sustainable way to cover tuition fees over time, rather than relying on loans with higher interest rates.
- Home Equity Preservation: Instead of using a HELOC for temporary expenses, some homeowners use it to preserve their home equity. By accessing funds only when truly necessary, they maintain a valuable asset for the long term.
Considering Your Financial Goals The decision to use a HELOC temporarily or as a long-term strategy depends on your financial goals, needs, and risk tolerance. Before making a choice, consider factors such as interest rates, repayment plans, and the potential impact on your home equity.
Here’s How I Use My HELOC:
I have a HELOC through my local bank. I met with the rep and she explained to me the process, how it works, and the costs (there weren’t any!). Every bank is going to have different options and perks–some may have a lower interest rate for a certain amount of time, some may even offer a fixed rate. I recommend finding a HELOC option that doesn’t have any upfront costs–no closing fees, no appraisal fee, etc. My HELOC shows up as just another account and I can transfer money in or out of it—if I’m going to pay for a renovation out of my HELOC, for example, I simply transfer the amount that I want to use out of that account into my primary checking account. When I’m ready to pay that back I can transfer the total amount or I can pay any amount I chose or pay interest only–it’s your call.
Whether you’re planning home improvements, navigating unexpected expenses, or looking to seize investment opportunities, a HELOC offers you financial flexibility like no other. As a seasoned real estate professional, I’m here to guide you through the intricacies of home ownership, ensuring that you make informed decisions that align with your financial aspirations and homeownership journey.
Bonus! How Can a HELOC Help Improve Your Credit Score?
- Diversification of Credit Types: A HELOC is considered a revolving line of credit, different from installment loans like mortgages or car loans. Having a mix of credit types can positively impact your credit score by demonstrating your ability to manage different types of debt responsibly.
- Lower Credit Utilization Ratio: Your credit utilization ratio is the amount of credit you’re using compared to your total available credit. A HELOC can increase your available credit limit, potentially lowering your credit utilization ratio and positively influencing your score. I rarely use my HELOC–since it doesn’t cost me anything and gives me a safety net it’s a great way to improve your credit score if needed!
- On-Time Payments: Consistently making on-time payments towards your HELOC shows responsible credit behavior. Payment history is a significant factor in your credit score calculation, so timely payments can contribute to a higher score.
- Increased Credit History Length: The longer your credit history, the better your credit score. A HELOC’s draw period, where you can borrow and repay, can extend over years, contributing to the length of your credit history.
- Improving Your Debt Mix: A HELOC can help you manage existing debts by consolidating high-interest debts into a lower-interest HELOC. This can streamline your debt payments and improve your overall credit profile.
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