Is a HELOC a Good Idea?

Is a HELOC a Good Idea

Your home may be an investment that allows you to build your wealth. But it’s not always easy to tap into the equity in your home. Real estate is an illiquid asset, meaning that the investment you make in your home cannot be taken out at a moment’s notice.

It’s not impossible to tap into your home equity, however. You can use something called a home equity line of credit, or HELOC, to tap into the value in your home without needing to sell it.

A Quick Recap: What’s a HELOC?

A HELOC is a line of credit that’s tied to your home’s equity. A simplified way to think about how much equity you have is that it is equal to your home’s value minus what you owe on your mortgage(s).

Your equity goes up as you pay down your mortgage — but it can also go up if your property’s value increases. You’ll need at least 20 percent equity in your home if you want to leverage it through a line of credit.

Here’s how it works: you can approach a lender or financing partner to request a HELOC. They’ll extend you that line of credit if you’re approved, and you can draw upon that line of credit to make purchases.

A HELOC works a bit like a credit card in this sense, but unlike a credit card, you don’t need to repay your balance each and every month. You can use a portion of your line of credit and hold that balance for the length of the term on your HELOC, which will vary depending on what you agree to with your lender.

How a HELOC Can Benefit You

The ability to withdraw funds when you need to and pay them back when convenient is one major advantage of having a HELOC. You can enjoy a lot more flexibility, and you only need to pay interest on the amount you withdraw and not on total amount available to you.

That allows you to only pay for the money you actually need, which could come in handy if you want to use your line of credit to finance something where the end price is a little flexible (like a home remodel).

HELOCs are a form of debt, meaning that if you withdraw funds you need to pay them back. It’s not always a good idea to use your home equity in this way. All homeowners should be careful not to overextend themselves or take on more payments than they can afford. In some cases, a HELOC does make sense because it can allow you to make your home more livable and add value to your property through a renovation or remodel.

When You May Run into Problems with HELOCs

While there are many advantages to leveraging a HELOC to tap into your home equity, there are some downsides you need to be aware of before you apply for a line of credit and start using your home’s equity this way.

Even though you only need to pay interest on what you borrow, you still need to pay interest — and that’s more expensive than simply saving up the funds you want or need.

And remember that not all HELOCs come with fixed interest rates. That means you could end up paying a lot more than you expected should your original interest rate go up.

Some HELOCs also come with complicated terms with a lot of rules about when you can borrow money and when you have to repay it. Look out for phrases like advanced period or balloon payment terms and make sure you understand everything you’re agreeing to before you sign any paperwork to originate your HELOC.

Should You Get a HELOC?

If the upsides outweigh the potential downsides of getting a home equity line of credit, you can talk to a lender about the application process.

Keep in mind you’ll likely need an appraisal on your home, and originating the line of credit comes with fees. You should factor in those costs to any evaluations on whether you can afford to dip into your home equity or not.

But first, make sure a HELOC truly is right for you.

A HELOC allows you to use money as you need it, and only pay interest on what you actually borrowed. This might be a good way to keep financing costs down while allowing you to stay as flexible as possible. But it comes with a cost.

The biggest drawback to using a HELOC may be that you could lose your home if you default on the payments. For that reason, it’s very important to seriously consider the risks before using a product like this.

You should only look for financing if you’ve already established sound financial habits and understand how to manage your money wisely. If you don’t have a plan to repay what you withdraw from your HELOC, think twice before trying to dip into your home equity. You could end up in a lot of financial trouble if you’re not careful about how you leverage this debt.

If you don’t want to take on debt at all but still need to tap your home equity, you could consider a home ownership investment through the Unison HomeOwner program. You can learn more about home equity and how Unison helps homeowners on the Unison website.

About the Author
Kali Hawlk