If you’ve heard the term “second mortgage,” you’ve probably also heard of a home equity line of credit (HELOC). With a HELOC, financial institutions give homeowners the opportunity to set up a line of credit based on the value of their house, usually at a lower interest rate than other types of loans.
Did you know that you don’t have to use your HELOC just for home updates? Use the money to cover college expenses, pay down debt, buy a car or budget for a host of other financial obligations. But, while there are many uses for a HELOC, it may not always be the best option.
Here are some examples of when a HELOC is beneficial, as well as some circ*mstances when you may want to avoid it.
When a HELOC is best
Unlike a home equity loan, which allows homeowners to take out a loan on the amount of equity they have in a property, an equity line of credit or HELOC remains unused until the borrower needs it. Once in place, you can withdraw money in small increments, as needed, paying it back as directed by the loan terms. This type of loan is ideal if you need money for a remodeling project or a child’s college education.
You can read more about the difference between home equity loans and HELOCs here.
Another benefit is that it can help you improve your credit score. Before using a HELOC, it’s important that homeowners evaluate whether it’s a wise investment and determine how it will impact their home’s equity. If the money is being put toward renovations, for instance, the homeowner could lose money if the full project cost can’t be recouped when the home is sold.
When to consider other options
A HELOC can be valuable in consolidating and paying down high-interest debts like credit cards. However, if you’re only going to mount more debt in the process, charging your limit on those newly-paid down cards, the money you take from your line of credit may only prove to send you further away from your financial goals.
That's why it’s important to have a plan before borrowing money on your home’s equity, whether in the form of a home equity loan or a HELOC. If the move is part of a long-term plan to become debt-free, it can make all the difference.
It may be tempting to use your home’s equity to invest in the stock market, thanks in large part to the potential for high returns. But the stock market is always a gamble, even if you think you have a sure thing.
Experts advise against using loan money to buy stocks—you can possibly lose the money and be stuck with a loan you can’t afford to repay. You should also avoid using a HELOC to invest in luxuries like vacations, since the money will be gone quickly without an asset to sell if you end up needing the money down the road.
A home equity line of credit is a great way to have extra income at your disposal. If you happen to need it, you’ll always have it on hand. However, it’s important to make sure your HELOC is part of an overall savings and debt-reduction strategy to keep it from hurting you financially.
