You get the requests in the mail. You’ve heard your friends talk it. You’ve probably even seen little pamphlets and advertisements in your local bank. The home equity line of credit (HELOC) is everywhere. But should you get one? And, if you do, what’s the smartest way to use it? In this article, we’ll discuss all of this and more.
What is an HELOC?
As NerdWallet explains, “A home equity line of credit gives you access to a sizable pool of cash, usually up to about 85% of your home’s value, less the balance remaining on your mortgage and adjusted based on your creditworthiness and ability to pay.”
They give the example of someone who owns a $500,000 home with a balance of $300,000. Once you take the 85 percent of the home’s valuation ($425,000) and subtract the amount still owed ($300,000), you get a $125,000 maximum line of credit. While you might not have nearly as much equity, you can plug in your own numbers to get a better idea of how much you may be able to obtain. (Your local bank or credit union should be able to pre-qualify you pretty quickly, too.)
An HELOC acts much like a credit card. You’re approved for a certain amount and can choose to use none, some, or all of it. When you do use it, the balance is subject to variable interest rates.
3 Smart Ways to Use Your Line of Credit
An HELOC can be used on virtually anything – that’s both a good and bad thing. But what are the smartest ways to use a line of credit? Let’s take a look:
- High Returning Home Improvements
The number one way to use a line of credit is on high returning home improvements. The key words here are “high returning.” Using an HELOC to build a $50,000 home theater in a $200,000 house doesn’t make much sense. Using $20,000 to modernize an outdated kitchen or add a bathroom makes sense.
The smartest option is actually to use an HELOC to pay for a much-needed renovation just prior to selling. The renovation will allow you to get more money for the sale, and you can immediately pay the line of credit off at the closing table.
- Consolidating High-Interest Debt
Are you saddled with a number of fragmented loans with high interest rates? It could make sense to pay off these debts with an HELOC. Not only does it save you a bunch of money, but it makes things a lot easier to manage when you only have to make one monthly payment, as opposed to four or five.
For example, let’s say you have $25,000 in student loan debts with a 7 percent rate, $10,000 in car loan debt with a 9 percent rate, and $5,000 in credit card debt with a 15 percent rate. You could use $40,000 of your $50,000 HELOC to refinance all of these payments down below 5 percent.
- Funding an Emergency
While not ideal, you can use an HELOC to fund an emergency if you don’t have the extra cash lying around. An emergency might be something like a surgery, funeral expenses, or totaled vehicle.
If you do choose to use your HELOC to fund an emergency expense, make sure you start paying off the line of credit immediately. The last thing you want is to get behind on your HELOC and end up having your house foreclosed on.
4 Terrible Ways to Use Your Line of Credit
Because an HELOC doesn’t come with many stipulations on how it can be used, you can make some pretty big mistakes if you aren’t careful. Here are some of the worst possible ways you can use your line of credit:
- Pay for a Vacation
You’d be amazed to learn how many people actually finance a vacation on an HELOC. They think that because they have $5,000 or $10,000, they can use it to take a dream vacation. And while they technically can, they’re ultimately going to return to a sizeable debt payment. The absolute worst thing about financing a vacation on an HELOC is that the vacation comes and goes. You come back and don’t have anything tangible to justify the debt.
- Paying for a Child’s College
A lot of parents who haven’t been wise about investing for college and don’t want their children to be saddled with student loans will finance tuition with an HELOC. While you may be able to do this effectively, there’s a pretty big chance that it will backfire. If you suddenly start having issues with monthly cash flow, your child’s education could ultimately force you to sell your home.
- Investing in the Stock Market
Many homeowners have this idea that they can turn a $10,000 line of credit into $100,000 overnight using the stock market. The problem is that investing in the stock market is risky and requires patience over a number of years. Is it possible to double your money overnight? Well, sure. But it’s also possible to lose everything. Using an HELOC to invest in the stock market is essentially gambling away your home.
- Buying a Car
There are extreme scenarios in which your only option may be to buy a vehicle with an HELOC, but it’s definitely not something you should do on a whim. On its own, financing a car is one of the worst financial decisions you can make. Throw in an HELOC – which is tied to your home – and you’re playing with fire. Vehicles are depreciating assets and quickly put you in a position where you have negative equity.
Contact Green Residential
At Green Residential, we’re one of Greater Houston’s premier names in the real estate industry. Whether you’re looking to buy, sell, or have someone manage your investment properties, we can help you get where you need to be. We’ve been in the industry for more than 30 years and take pride in helping our clients achieve their personal and financial goals. For more information, please contact us today!