A home equity line of credit (HELOC) allows you to tap into the asset created by the appraisal value of your home, less any outstanding mortgages or other liens.[cite::219::cite] If you owe $150,000 on a first mortgage and your home could reasonably sell for $300,000, banks offer a line of credit up to the $150,000 difference.
Unlike second mortgages, acquiring a home equity line of credit doesn't require you to take receipt of any funds at closing. This type of loan is a revolving line of credit in which the equity in your home determines what limit is affixed to the line. In addition, should you choose to access the available funds, your interest rate, along with the term of the loan, helps dictate what your monthly repayment figure will be.
Who Should Access a Home Equity Line of Credit?
HELOCs work well for homeowners who have adequate means to make those monthly payments. Banks will analyze creditworthiness, income, assets, and debt-to-income ratio to ensure that borrowers have sufficient means to repay, should they choose to access minimal funds or the maximum limit offered.
On the other side of the equation, HELOCs aren't an ideal option for individuals or couples who have sporadic income or large amounts of existing debt. Missing payments in turbulent financial times could mean losing your home to foreclosure.
Five Smart Uses for a HELOC
You can open a home equity line of credit and treat it like an emergency reserve for unexpected expenses. However, most applicants secure the line with a specific purpose in mind.
1. Home Improvements
You've always wanted that new deck. A HELOC could finance that dream, and the new addition could boost the value of your home—possibly beyond the cost of the project, in some cases. Be certain to have room in your budget to repay the amount used for the home improvement project.
2. College Expenses
Do you have an aspiring college student? HELOCs can supplement guaranteed student loans or qualified tuition plans, also known as 529 programs, to help ease the cost of college tuition and expenses.
3. Certain Investments
Perhaps there's a stock you've had your eye on. If the annual return on that investment consistently exceeds the interest rate on your HELOC, using the credit line for the investment could be a prudent move.
4. Retirement Income
If you were a little late saving for retirement or your investments are under-performing, a HELOC could be used temporarily to create income, until your portfolio recovers.
5. Starting a Business
It may be a bit risky, but a HELOC could be tapped to help cover business startup costs. However, it would be wise to factor in repayment into your business plan.
Summing It Up
As a homeowner, a home equity line of credit gives you financial flexibility. With fixed interest rates still hovering around historic lows, the cost of borrowing remains reasonable. If you perform due diligence and conduct a prudent financial analysis, an equity line may be a sensible way to create wealth or finance dreams.