How to Use Your Home Equity Wisely
If you own your home, you probably have access to more capital than you think, thanks to a little something called a home equity line of credit (HELOC). A HELOC is not a home equity loan. Though the two may sound similar, and both allow you to borrow against the equity you’ve built up in your home, the similarities stop there. While home equity loans are dispensed as large lump sums and are typically repaid at fixed, predetermined rates, a HELOC functions more like a credit card. It’s a revolving line of credit that is secured by the borrower’s home, which means that the borrower uses their home as collateral for the loan.
Essentially, it works like this. The lender—typically your financial institution, such as a credit union or bank—calculates your equity based on the appraised value of your home and the amount owed on the mortgage. In doing so, a credit limit is established that lets you know the maximum amount you can borrow. The process is then broken into two phases.
The draw period is the specified amount of time when you can access your line of credit as much or as little as you like, up to the credit limit, and you only pay interest on what you borrow. Not all draw periods are the same length, but 10 years is the most common.
The repayment period, where the line of credit becomes inaccessible, is when you have to pay off the loan, usually in monthly installments that include both principal and interest. The repayment period is typically 20 years, supposing the draw period was 10.
As long as you’re confident in your ability to pay off your HELOC during the repayment period, it’s a valuable source of cash to have at your disposal. Here are 6 ways a HELOC can be of benefit.
1. Gain Financial Flexibility
There’s no restriction on how you use the funds you borrow with your HELOC—it’s completely up to you. You can also repay the funds you’ve borrowed during the draw period, which replenishes the available balance. And as mentioned before, you don’t pay interest on the full value of the HELOC—only the amount you borrow.
2. Raise the Value of Your Home
One of the primary reasons the HELOC was created was to allow homeowners to access funding to invest in their properties. Making home improvements or renovations can net you significant profits in future when you choose to sell.
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3. Enjoy Potentially Lower Interest Rates
It’s important to bear in mind that the interest rate for a HELOC is variable and can change based on market conditions—unlike a home equity loan, which has a fixed interest rate and is disbursed as one large sum that must all be repaid. Having said that, the interest rates for a HELOC are typically lower compared to other forms of borrowing, such as credit cards or personal loans, because they’re secured by the home.
4. Be Prepared for An Emergency
Having an emergency fund is key to achieving a feeling of financial freedom, and a HELOC ensures that you have one. If a crisis occurs or you find yourself out of work, a HELOC provides the peace of mind that you have accessible funds at hand, without having to resort to other forms of borrowing.
5. Give Your Credit Score a Boost
Anytime you make consistent, timely payments against credit debt, you’re demonstrating good borrowing behavior and having a positive impact on your credit. Therefore, a HELOC is a great way to improve your credit score, making funding even more accessible to you in the future.
6. Benefit from Potential Tax Savings
While it will depend on your personal situation, as well as the distinct tax laws in the jurisdiction where you live, interest paid on a HELOC may be tax deductible. Essentially, a HELOC is more or less a type of mortgage, meaning that in many cases, borrowers who itemize can deduct the interest paid on up to $100,000 in loan principal.
You should always consult with a trusted financial professional at your credit union or bank to fully understand whether or not a HELOC is right for you, because borrowing against your home does carry some risk, especially in an environment with rising interest rates. But for you as a homeowner, this type of loan is a handy tool to have in your toolkit.