​What Is a Home Equity Line of Credit?

As homeowners pay off their mortgage over time, they’re also building up home equity, and acquiring the financial flexibility it can provide.

Home equity is the value of a homeowner’s stake in their property. To calculate yours, determine the current market value of your home, and subtract the remaining amount still owing on your mortgage.

If you have a significant equity stake in your home, generally at least 35 percent or more, you can tap into that value with a home equity line of credit, or HELOC. If you already own your home outright, you can still get a home equity line of credit – you’ll have even more equity to take advantage of.

What is a home equity line of credit?

Like a credit card, a line of credit provides revolving access to a fixed amount of cash. You borrow what you need from that total and pay it back over time, plus interest.

Say you have a line of credit worth $75,000 and borrow $15,000 to fund a major purchase. You still have $60,000 left to use, and that amount increases as you pay back the borrowed funds.

There’s no interest on funds you don’t borrow from the line of credit, and the fees and costs charged for a HELOC are typically lower than for most types of loans.

With a home equity line of credit, the maximum amount the homeowner can access is usually a set percentage of the home’s value, generally between 60 and 80 percent, minus the amount still owing on the mortgage. For instance, if your home is worth $500,000 and you owe $175,000, you could access up to $225,000 (500,000 x .8 = 400,000 – 175,000 = 225,000).

Unlike credit cards, interest rates are typically low on home equity lines of credit, because they are secured by the property itself. The consequence, however, is that your lender has a claim to your home if you are unable to repay your debt. As such, it’s wise to avoid borrowing too much against the value of a property and running the risk of losing your home.

What can a home equity line of credit be used for?

A line of credit is like having a financial security blanket you can use for any expense, unexpected or otherwise, that’s too big for your savings to handle.

A home equity line of credit can be a great way for homeowners to pay for home improvement and renovation projects, major purchases such as a vehicle, medical or education costs, to fund investments, or to cover emergency expenses.

Use a HELOC to increase the value of your home while also raising your equity stake

A renovation project that increases the market value of your home will, in turn, give you greater home equity. Whether it’s a new kitchen or bathroom, finishing a basement, building an addition, or even adding a backyard pool, there are countless ways to make your home more marketable, boosting its value and the value of your equity stake.

If you want to renovate but don’t have the savings to pay for it, you could finance the project by borrowing against your home equity, making use of your ownership stake while simultaneously increasing the home’s value.

When not to use a HELOC

Although having a home equity line of credit is a valuable addition to your financial tool belt, it’s not something you want to use indiscriminately, especially because failure to pay back what you borrow could lead to you losing your home.

In general, it’s wise to steer clear of using a HELOC if your income is unstable or inconsistent, threatening your ability to make regular payments. A HELOC is also not the best option if you don’t need to borrow very much money, as it would likely be cheaper to use your savings and avoid the costs and fees involved with a loan or line of credit.

Likewise, while it may be tempting to pay for a vehicle or a children’s post-secondary education with a HELOC, it’s generally better to fund these costs with a car loan or student loan instead, because your home won’t end up being collateral for the debt. Plus, a car is a depreciating asset with a limited lifespan, meaning you might end up repaying the cost of a vehicle beyond its useful lifespan.

Finally, if you’re thinking of getting a home equity line of credit, run the numbers first to make sure you’ve got the financial bandwidth to withstand the bigger payments you’ll have to make if interest rates go up. HELOCs typically have variable interest rates, meaning the interest charges will rise and fall over your borrowing period, altering your repayment amount from month to month.

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