A home equity line of credit (or HELOC, as it’s called in the acronym-drenched world of finance) works a lot like a credit card, with one big caveat: Your home is on the line as collateral until you’ve paid off the debt. Many people refer to a HELOC as a second mortgage because it’s backed by the value of your home, just like your original mortgage.
A HELOC lets you borrow up to a certain amount of money by withdrawing it as needed at any time during the draw period. As you pay it off, that credit becomes available to use again. At the end of the loan, typically five to 15 years, the entire debt must be paid off, and your lender may or may not authorize a renewal. And while it’s an unlikely scenario, if you find you can’t pay off the loan, you could lose your home.
Should you pay with your HELOC?
With your home on the line, a home equity line of credit isn’t something you should tap for a big vacation or a new wardrobe. Reserve using your HELOC for necessities or things that will prove to be an investment in your finances or in your future: home repairs, your own education, or when times get tight. New cars, home renovations, and the kid’s college tuition have long been traditional choices to be financed by a home equity line of credit—but how smart are those choices?
New car: No. Let’s open our list with a prime example of something you probably don’t want to pay for with a second mortgage on your home. The variety and flexibility of today’s car loans and lease options provide plenty of reasonable financing options without having to put your home at risk.
Home repairs: Yes. When you need to repair a vital system in your home such as your heater, a major appliance, or structural damage, a HELOC is a logical place to turn. Why not put the value of your home to work to ensure it maintains its value?
Home renovations or remodeling: No. On the other hand, financing a renovation or remodel with a home equity line of credit doesn’t make as much sense. It’s a common strategy, but not a smart one. Will potential buyers love those new kitchen appliances you’d like to install, or will they want to tear them out to replace with something they prefer? Remodeling may not increase your home’s value or pay off in the long run, so pay cash instead.
Vacation: No. Why would you risk losing your home if you were forced to default on a loan padded with luxurious weeks on the beach or winter ski breaks? Don’t risk it.
College tuition for your children: Maybe. Relying on the value of your home to pay for your child’s college tuition may sound like a smart idea, especially if you can get an interest rate that’s lower than the loans your child can obtain. And a HELOC might be a better deal than falling back on, say, your credit card. But like putting on your own oxygen mask during an airplane emergency before helping your children with theirs, the important thing to remember in finance is to save yourself first. Don’t put your home at risk or stretch your financing too thin to pay for the kids’ education before you’ve secured your own financial future.
Budgetary crisis: Yes. There are some types of HELOCs that offer an interest-only payment option; which can make them a smart choice when a financial emergency hits and your budget is severely crunched. Just be sure to start paying on the principal as soon as you can once things loosen up again.
Are you ready to see how a home equity line of credit could help your finances? A PenFed home equity line of credit gives you access to funds when you need them, including interest-only payment options.