Best 6 ways how to use a home equity line of credit wisely

Tips for how to use a home equity line of credit (HELOC)

Wondering how to use a home equity line of credit to reach your financial goals? This article highlights:

•  A home equity line of credit is a line of rotating credit that uses the equity you have built in your home as collateral

• HELOCs usually have lower interest rates than other loans and credit cards, making them a good tool to reach your financial goals or to help you in an emergency

• The best ways to use home equity include making home improvements, consolidating high-interest debts, paying for college or elder care,  or making investments in another home or business

Home equity is a powerful financial tool if used correctly. Some of the most popular tools to access the equity you have in your home are home equity credit lines, or HELOCs, home equity loans, and cash-out refinances. If you've worked hard to pay down your mortgage, you can use your home equity to fund a number of projects. But make sure to use your home equity funds wisely. Using this loan to buy a fancy car or fund a lavish vacation isn't a great investment since you'll be paying interest on your purchase long after the car is gone or the travel memories have faded. In addition, you could be putting your home at risk for short-lived luxuries if you run into financial trouble down the road. The smartest way to use a home equity line of credit is for investments in your future. Take a look at these smart ways to get the most out of your home equity line funds.

What is a home equity line of credit (or HELOC)?

A home equity line of credit is a loan that allows homeowners to borrow funds against the value of their home, based on the amount of equity they have. Equity is the share of your home that you own, versus what you owe on the mortgage. HELOCs offer several distinct advantages: flexibility, often lower interest rates, and providing a revolving line of credit during the initial "draw period" (usually the first 10 years). Monthly payments can generally be made during the draw period if you so chose, but are required during the second phase, the repayment period. It is different from a traditional home equity loan, in that you draw money out of the credit line as needed instead of receiving an initial lump sum. With a HELOC you will only pay interest on the portion of the credit line you withdraw, whereas, with a home equity loan, you pay interest on the entire amount. Another alternative is a cash-out refinance, which replaces your existing mortgage with a new one with higher monthly payments. In return, you receive a portion in a one-time payment. 

Through a HELOC, homeowners can draw cash from their home's equity and use it for whatever purpose they deem fit. By paying back the money and interest over time, your home's value increases while slowly building personal wealth. Although it can be a helpful option to cover large expenses or consolidate debt, you should always keep in mind that if payments are not kept up, you risk losing your house. Homeowners must make sure they are able to cover the cost of the home equity line of credit payments in addition to their existing mortgage. Homeowners should also make sure that they understand all fees and closing costs associated with the home equity line that they chose, as well as if it is a fixed-rate HELOC or a more risky variable interest-rate equity line.

Top 6 ways to use a home equity line of credit wisely

There are no restrictions on how you can use money from your HELOC. However, if used wisely, a home equity line can be part of a smart financial long-term strategy. By helping you pay off high-interest debts sooner, increasing your home value, or investing in other projects, you can make the most of the equity you have built in your home. 

1. Make smart home improvements

One of the best ways to use a home equity line is to fund improvements to your house and property. Use the money to pay for necessary repairs like a roof replacement or for important upgrades like bringing your electrical system up to code. You may also consider building an addition on to your house or making improvements to the interior or exterior that will make your home more comfortable. Choose projects that will increase the resale value of your home, and you'll be paid back when you sell in the future. Smart choices are also ones that increase your curb appeal when you sell, such as fresh paint or new siding.

Best of all, there are tax advantages to using a home equity line for home improvement projects. Despite changes to tax laws, home equity benefits are still available, including deducting interest payments made on your HELOC on your taxes on mortgage and home credit lines up to $750,000. 

2. Consolidate high-interest debt

The average interest rate on a new credit card is over 19%. If you are carrying a balance on one or more credit cards or have a zero-interest introductory offer that is ending, using a home equity line to pay them off could save you thousands of dollars in interest on your credit card debt and, in turn, help you pay off your debt much faster. Current home equity line rates are less than half of what a credit card company typically charges, so consider using a home equity line to consolidate your debt.

3. Supplement your emergency fund

A home equity line of credit makes an ideal emergency fund, especially if you're struggling to save the three to six months of living expenses that experts recommend keeping for a cushion. Knowing that you can tap into your home as a source of income in case of emergencies can provide peace of mind. If you unexpectedly have to replace your furnace midwinter or get laid off, you'll be able to weather the storm. A HELOC is better than a personal loan for this, because if you don't withdraw money from the credit line, you will not be charged interest on it. However, it's better than a credit card because the interest rate is usually significantly lower. 

4. Make college more affordable

The average college graduate now carries $37,172 in student loan debt — a figure that can keep them from moving out of their parents' homes or pursuing a higher degree. A college education is still a good investment, though, so you may wish to tap into a home equity line of credit to pay for your child's tuition or living expenses. This payment method can help you avoid high-interest private loans marketed to parents (Parent PLUS loans). It's a great option if your financial aid package doesn't include enough subsidized federal student loans to cover all your costs.

5. Care for an elderly parent

If you have aging parents, a home equity line can help you cover the cost of a nursing home or other long-term care option when they can no longer live on their own. It can be difficult to budget for this type of expense if you're faced with a sudden loss of mobility or other health crisis. A home equity line can fund the down payment on a nursing home at a lower interest rate than available on other types of loans.

6. Move into a new home on your own schedule

Whether you want to downsize or need extra space for a growing family, moving is nerve-wracking. This is especially true if you are trying to time selling your old house to coincide with buying the new one. Using a home equity line for a down payment gives you the flexibility to pay for your dream home without needing thousands in cash on hand, and it allows you to move into your new house while you wait for your old one to sell. This use of a home equity line is best for those who can afford two mortgage payments at once for a few months. This home equity line will be paid in full at the close or sale of your old house.

What are the worst ways to use a home equity line of credit (HELOC)?

Using a Home Equity Line of Credit (HELOC) can be an effective way to make a large purchase or investment. However, irresponsible use of a HELOC can put your home at risk, since the loan is based on the equity you’ve built up in your home. During the Great Recession, too many borrowers found out the hard way that their homes had declined so much in value that they owed more money than their homes were worth. And if you fail to make payments on your HELOC you are at risk of losing your home. To ensure you don’t put yourself in this position and protect your equity, there are certain things to avoid when using a HELOC. It is best to avoid using HELOCs to pay for unnecessary luxuries, such as expensive cars, extravagant vacations, and big weddings. While you may make great memories, you will be left paying the price tag for an extended period of time and could even lose your home. 

The bottom line

A home equity line allows you to tap into the investment you've made in your home, making it a great tool for people who may not have a lot of income but who have been diligent about keeping up with their mortgage payments. While you'll still pay interest on the money you borrow against your house, low-interest rates make it a valuable option for funding investments in your future and improving your quality of life.