What is a home equity line of credit and what can you use it for?

Owning a home comes with many advantages, whether you’re focused on the financial aspect, like the tax benefits, the surface-level perks, like the option to pick out your own paint colors, or simply the pride that comes with homeownership. But, you may be missing out on one of the greatest benefits: tapping into your equity with a home equity line of credit (HELOC). Here, we’re diving in and explaining what a home equity line of credit is, how it works, and some popular ways to use a HELOC:

What is a home equity line of credit?

A home equity line of credit is a revolving line of credit that uses the available equity in your home as collateral. A line of credit is an agreed-upon amount you can draw from when needed—similar to a credit card. The amount available for you to borrow depends on your credit score, debt-to-income (DTI) ratio, and the equity in your home. HELOCs are secured by an asset (your home), so they generally have higher credit limits and lower rates versus credit cards and personal loans.

How does a home equity line of credit work?

A HELOC works by determining the amount of equity available in your home. This is calculated by taking the estimated value of your home minus any liens, like your mortgage. Most qualified borrowers can take out up to 80% of their home’s equity. For example, someone with a good credit score and low DTI ratio with a home valued at $400,000 and a loan balance of $150,000 could be approved for a HELOC up to $200,000 ($400,000 – $150,000 = $250,000 x 0.80 = $200,000). HELOCs usually have low or no origination fees and are relatively easy to get.

When you have a HELOC, the terms have a draw period and a repayment period. During the draw period, you can withdraw from your line of credit at any time and make interest-only payments. When the draw period ends, you make larger payments to repay the balance owed. Most HELOCs have a draw period of 10 years and repayment periods as long as 30 years.

What can you use a home equity line of credit for?

A home equity line of credit is typically used for renovations—but that’s not your only option. You can use a HELOC to tackle other major life costs as well. Here are a few popular ways you can use a HELOC:

Renovations

HELOCs are often used for home improvements or repairs like a bathroom remodel or a kitchen renovation. They’re popular for home renovations because they offer tax-deductible interest payments¹, which could help you save big come tax time if you use the funds to substantially improve or repair your home. Because home improvements are often long projects, a HELOC is also helpful because of the extended draw period, so you can access money over time as needed.

Education

Another popular expense for HELOCs is college tuition. This is ideal, again, because of the long draw period. You can withdraw funds as needed, like tuition for a semester, and owe interest only on what you borrow. You likely want to check out all student loan options before choosing this route—you’d want HELOC rates to be lower or competitive compared to federal student loan rates.

Consolidating debt

If you’ve racked up a ton of high-interest credit card debt paying for large expenses, like medical bills or a wedding, a HELOC is an option to consolidate debt. HELOCs generally offer lower interest rates compared to unsecured loans—especially your credit card.

However, it’s probably not wise to take out a HELOC if you reached this point because of excessive spending. Otherwise, you’ll dig yourself into more debt. Remember, your house is collateral, and you could face foreclosure if you can’t afford to repay your HELOC.

You can also use HELOCs to consolidate student loans. Keep in mind, that by refinancing or consolidating federal student loans, you could lose out on certain benefits.

When should you not use a HELOC?

HELOCs can be helpful in many circumstances, but there are a few situations where you’re likely better off using a personal loan or other measures.

Weddings

Before you say “I do” to using your largest asset as a way to fund your wedding, think again. We get it—weddings have a hefty price tag, with the average wedding costing upwards of $35,000. However, using a HELOC to fund a single day isn’t the best use of funds. Instead, you’re better off using a personal loan or line of credit, or credit card (so you can rack up those points!).

Vacations

No matter how much you need some R&R, using a HELOC to fund your dream vacation isn’t the most sensible choice. Instead of using your most valuable asset to travel, plan for how much you’ll need and store your savings in a separate account just for your vacation.

Cars

Cars are a depreciating asset, meaning they lose their value over time. Therefore, using a HELOC to purchase your next vehicle isn’t the best choice because you’re putting your home—an appreciating asset—on the line. And, if your credit score is high enough to qualify for a HELOC, you’ll likely qualify for an auto loan, which you should use instead.

Key takeaways:

• HELOCs are a revolving line of credit that uses your home as collateral. This means you can borrow money against the value of your home but with potentially lower interest rates and higher credit limits than unsecured loans.
• HELOCs have two key phases: the draw period, which allows you to withdraw money from your credit line and make interest-only payments, and the repayment period, where you pay back the principal and interest owed.
• HELOCs can be a good option for financing various expenses, like renovations, education costs, or consolidating high-interest debt, but there are also situations where they’re not ideal, like frivolous spending or depreciating assets, like cars. 

¹Please consult your tax advisor.