Making Smart Choices with Home Equity Lines of Credit

A Home Equity Line of Credit (HELOC) can be a valuable and convenient way for homeowners to access the equity they have built in their property and help meet cash flow needs. A HELOC allows borrowers to draw funds as needed, making it a popular choice for financing home renovations, debt consolidation and other expenses. While it may be a more attractive option than traditional loans or other forms of borrowing, it’s important to be aware of not just the opportunities it creates, but potential pitfalls, as well.

How home equity lines work
A HELOC is a revolving account that can be established for a set amount (limited to a percentage of your equity in the home) and accessed as funding needs arise. While there are some nominal costs associated with establishing a HELOC, it is typically less expensive to set up than other forms of borrowing.

An interest rate is associated with any funds you borrow through your HELOC. In most cases, the rate charged will be variable, subject to change as market interest rates move up and down. Interest is only charged when you’ve borrowed money.

Making good choices with your HELOC
Borrowing against your home equity may be most effective when:

• Paying off loans with a higher interest charge, such as credit card debt

• Investing in a home improvement that may increase the value of your home over time

• Funding a big-ticket purchase that can be classified as a necessity, such as another car for the household

• Paying for a major, unexpected expense or providing a financial bridge if you should lose your job

Prudent borrowing is important with a HELOC. For instance, it’s best to avoid borrowing from this source of funds to make frivolous purchases or to pay for a vacation. When used, this money should provide a long-term benefit that will make the months and years of repayments and interest charges worthwhile.

Other considerations
While HELOCs offer tremendous benefits to those who have built up significant home equity, it’s important to understand potential downsides to this form of borrowing. Consider that your home -- perhaps one of your most important financial investments and, quite literally, the roof over your head -- is being used as collateral to fund other expenses. That creates a risk in the event the market value of your home should decline, which may require you to pay back the debt sooner. Or, if you miss payments, the borrower could foreclose on your property.

Even though the HELOC is based on your home’s value, interest is not completely tax deductible. Only interest on funds borrowed to buy, build or substantially improve the home can be deducted.

One additional caution is to avoid looking at a HELOC as a readily-accessible piggy bank. You need to be discerning in how you use this resource, as the money does have to be paid back with interest, which can create a future financial burden if not used judiciously.

Consider HELOCs as part of your plan
As you weigh the potential of a HELOC, assess how it will work with your overall financial plan. It can help to talk to an advisor about the pros and cons for your own unique circumstances.