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When you should (and shouldn’t) use a HELOC

Home BlogWhen you should (and shouldn’t) use a HELOC

Key takeaways:

  • A HELOC is a home equity line of credit; a loan that allows you to borrow money based on the equity in your home.
  • As with any line of credit, it’s important to understand the benefits and downsides.
  • Before deciding on a HELOC, consider interest rates and the amount of equity in your home.

What’s a HELOC? A HELOC, or home equity line of credit, gives you the ability to access the equity you have built in your home as a line of credit.

This can be beneficial for you because it can serve as a convenient and often inexpensive way to borrow money for things such as home renovations, education costs and more.

In fact, TransUnion reported the use of HELOCs is expected to double between 2018 and 2022. So, is a HELOC right for you? Let’s take a look at some of the benefits and downsides.

Benefits of using a HELOC

  • The benefit of using a HELOC is that it works in a similar way to a credit card, but usually charges a much lower interest rate. Say you’re doing a home renovation. Instead of getting a lump sum loan to pay for the expense at hand, you can open a line of credit. The bank will establish your credit limit based on your income, credit score and the equity in your home. If you have a lot of equity in your home, then a HELOC may be the right step for you. The limit is typically set by subtracting the balance you owe on your mortgage by a percentage of the appraised value of the home (usually about 90 percent).
  • Also similar to a credit card, you only pay interest on the amount you actually use. This is another benefit of a HELOC over a traditional loan, and it gives you room to spend within the preapproved limit.
  • The interest paid on your HELOC is often tax deductible, so it’s possible to save money on taxes. As always, you should consult a tax professional to discuss your unique situation and the deductibility of interest on your HELOC.
  • A HELOC can be used in a couple ways. You can use checks that are linked to your account, or you can use online banking to transfer money directly to your checking account.

Why a HELOC may not be right for you

  • Considering a HELOC is based on the equity in your home, this may not be an option if you have very little equity in your home. Perhaps you just purchased your home and you’re looking to update it? There are other ways to finance your home renovation that may be more efficient than a HELOC.
  • Because a HELOC is tied to the equity in your home, you could end up in foreclosure if you don’t pay it. As with any line of credit, you shouldn’t borrow more than you can pay back.
  • HELOCs are subject to underwriting standards, which means you’ll need to provide more information than when you apply for a credit card. As a rule, you’ll need to document your income and employment status, just like you would if you’re refinancing your home.
  • HELOCs have variable interest rates that are often significantly lower than credit card interest rates. Determine what the index and margin are for your HELOC. Many HELOCs use the prime rate as published in the Wall Street Journal for their index. This means the rate can change, so ensure you can pay even if it increases.

It’s important to weigh whether a HELOC is right for you before opening one. If you have questions about HELOCs, visit your local MidWestOne branch.

MidWestOne Bank does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

MidWestOne is pledged to the letter and the spirit of the United States policy for the achievement of equal housing opportunity throughout the nation. We encourage and support an affirmative advertising and marketing program in which there are no barriers to obtaining housing because of race, color, religion, sex, handicap, familial status or national origin.