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When You Should and Shouldn’t Use A HELOC

February 26, 2020

Similar to a credit card, a Home Equity Line of Credit (HELOC) provides consumers with the ability to borrow and repay as they withdraw, only with a significantly higher credit limit and often times, a lower interest rate. This allows consumers to tap into their home’s equity for a variety of reasons. Although a HELOC can be a sensible solution to gain access to a large cash reserve and overall help to improve finances, it can also become a burden if used in the wrong way. When determining whether your home’s equity is the best source for financing a big spend - consider these factors!  

When You Should! 
 

Making Home Improvements

One of the most common and practical ways to use a home equity line of credit is for property improvements. Using your home’s equity to invest in small improvements such as remodeling a kitchen, or a bathroom can increase the resale value of a home. Although homeowners might not see the value in remodeling initially, research has shown that a modern kitchen can account for up to 72% of a home’s value. But it’s also important to keep in mind that not all renovations make a valuable difference. Consumers should think twice before investing in luxury items, such as a pool or a backyard sports court. These extravagant items tend to not add enough value to support the expense. Additionally, consumers should consider how long they will reside in the house following the renovations to ensure they can afford to pay back the line of credit they’ve opened prior to their desired sell date.

Consolidating Debt

Taking advantage of a home’s equity to consolidate debt can save consumer’s a considerable amount of money in interest. An overwhelming amount of debt can be crippling and difficult for a homeowner to navigate. Using a HELOC to get out of debt and reduce high interest rates can have a positive impact on one’s financial well-being. If a consumer decides to use a HELOC, they should keep in mind that they are turning unsecured debt into secured debt, so being able to make the monthly payments is essential. It’s also imperative that consumers research the index and margins of the HELOC, as the rate can change. Rates are sometimes based off the prime rate, meaning that monthly rates can fluctuate, and payments can increase over the given period of time. Other times, HELOCs have a fixed rate.

Financing A College Tuition 

With tuition at an all-time high many consumers are struggling to pay college expenses in full. Using a HELOC can be a great way to lessen the burden for many families and help them save where they can. Oftentimes, HELOCs will have a lower interest rate and fees compared to other private loan options, which can reduce long-term borrowing costs. Consumers are also able to receive a larger cash reserve through a HELOC compared to a federal loan, as these have annual caps. Overall HELOCs provide the flexibility for consumers to take what is needed as they go, rather than just borrowing a large amount money all at once. Instead of consumer’s taking from their individual retirement fund, they can use a home equity line of credit as a sensible financing solution to pay for a college education! 

When You Should Not 
 

For Luxury Items

Being able to afford a fancy car, a boat, or even a big screen TV is nice, but unfortunately these items aren’t necessary. It’s easy to think that there is more money to spend with a line of credit but overspending and using equity as an ATM is not recommended. With a HELOC consumers are fully responsible for paying back the equity through monthly payments, plus interest. Remember, a HELOC is not free money, it’s actually a form of debt. Homeowners are tapping into their equity, not bringing it down. The main goal of a HELOC is to help homeowners, not to create more debt! 

As A Dependable Emergency Fund

Using a HELOC as an emergency fund is not the wisest choice. Due to frequent changes in the market, it’s not always the most dependable form of funding – especially in the case of an emergency. A HELOC might seem like the best way to stay afloat for short period of time, but it is important that the amount withdrawn can be paid back as promised per your agreement. Rather than taking additional equity, homeowners should prioritize small ways to reduce spending and build a “rainy day” fund for any unforeseen expenses. 

Overall building up equity in a home takes time and is worth protecting. Although a HELOC can be worthwhile in helping to improve the value of a home or to reduce high interest debt, it can also become bad debt if it’s used for unnecessary ventures. If you are someone who is still deciding if a HELOC is the Perfect Match or if you already have one, it’s recommended to consult with your bank first if you’re unsure it’s the best source for financing your next large expense.

James Oosterman is Senior Vice President at Melrose Bank. He can be reached by telephone at 781-665-2500.


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