If you’re a homeowner, you’re probably familiar with the term “HELOC” or, Home Equity Line of Credit. A HELOC is simply a second loan – most often taken out after the purchase – that sets up a credit line against the value in the home. Of course, you need equity in your property to be eligible for a HELOC but, at that point, you can spend the money just like you would with any other credit line or even debit card. During the real estate boom of the mid-2000s, HELOCs (and other second loans that took cash out of a property) were very popular, as it was a way to profit from rising real estate prices without selling or refinancing the first-position loan.
In fact, according to Transunion, approximately 10 million homeowners will take out a HELOC from this year through 2022, which is more than double the 4.8 million HELOCs consumers borrowed from 2012 to 2016.
These days, thanks to rising home prices in most markets across the country (and definitely in California!) we’re seeing a rise in HELOCs again. However, unlike during the past pre-Recession boom, it’s important that we use this loan as a responsible financial tool – not a free-spending ATM.
As a general guide, here are seven good reasons to take out a HELOC – and what to do with the money once we can approve your loan! Please contact me if you have any other questions about how a HELOC or refinance can save you money!
1. Make the RIGHT home improvements
Of course, the originally intended reason for HELOCs was to use the money to make improvements to your home, such as remodeling the kitchen, putting on a new roof, and building an addition. While it’s always great to reinvest in your home, it’s critically important that these improvements yield you a high Rate of Return. Not all improvements do, such as adding a swimming pool, remodeling the office or guest bedroom, or turning the attic into a playroom. There’s plenty of research (I can help you, too) that covers which home improvements will actually add to your value and pay off in the end, so use your HELOC wisely.
2. Pay for college or education
The cost of higher education has skyrocketed in the U.S. In fact, student loan debt has now surpassed $1 trillion – more than all of our credit card debt combined! With the average student loan holder now graduating with more than $30k in debt, our student loans crippling a whole generation (and others) from saving, investing, and buying homes. Therefore, we’ve seen a rise in parents who are kind enough to take out a HELOC on their own equity-rich homes to pay off their children’s student loans. While this makes financial sense in some cases, I would be careful since student loans are often offered at low rates and payback is spread out over an extended period.
3. Pay off debt
Credit card debt is also on the rise among U.S. consumers again, and auto loans have jumped up to record levels, as well. With all of this debt surrounding us, much of it is at high interest rates – sometimes even 10, 15, or 24%! For people who have a large chunk of credit cards or other debt with high monthly payments and are only making monthly minimums, it pencils out to consolidate (pay off) all of that debt using funds from your HELOC, which will be at a lower interest rate, amortized or spread out over a longer period, and probably tax-deductible. However, once you pay off your credit cards with your home loan and your budget is right-side up again, please use that windfall to save or invest responsibly – and don’t start spending on your credit cards again!
4. Invest
Sometimes, we have a business opportunity, investment, or even want to buy a rental property. In those cases, using money from your HELOC to acquire an asset that makes you money can be a great option. Just make sure that the investment actually produces cash flow or a rate of return, or else it’s just gambling with your home equity!
5. Emergencies
No matter how well we plan and how diligently we watch out finances, life sometimes hands us lemons. In fact, medical problems, job losses, divorce, and other setbacks often derail our finances. In that case, with little or no better options, some people turn to the equity in their homes as a temporary bridge to get them through to better times.
6. To protect your retirement funds
So many people are struggling to make ends meet in their 50s or even 60s, but know that if they can just make it a few more years, their pension, Social Security, and other retirement benefits will be coming their way. Faced with that situation, the worst thing they can often do is withdraw retirement funds like an IRA early, as they will get absolutely slaughtered on taxes and surrender fees. Likewise, many seniors take out a reverse mortgage, which isn’t always the most favorable resource for them if other options – like a HELOC – are in place. Sit down with your financial planner for and CPA for accurate advice about your specific situation.
7. Just to have it for a rainy day.
During the salad days of exploding real estate prices in the mid-2000s, many people were stretched thin on their monthly budgets but extremely equity rich. They considered the value in their home to be their safeguard against any financial problems and counted on that money being there. However, by the time they really needed it (job loss, rising interest rates, too much debt, etc.) they couldn’t always get access to that equity cleanly. In fact, once the market started sinking, banks scrambled to tighten their lending standards and even cancel existing HELOCs as quickly as they could. So, if we’ve learned our lessons, we might want to look at taking out a HELOC when times are good, and you can get approved, just in case!