If you have positive equity in your home as well as decent credit scores, a home equity line of credit (HELOC) may be one potential option for generating cash. Using a HELOC can be advantageous, but there are also many risks to consider before opening an account and drawing off your equity.
Pros of Using Home Equity Line of Credit
Using a HELOC allows you to obtain lower interest rates on borrowed funds. Your property acts as collateral for the secondary mortgage, thereby giving you potentially lower interest rates than you could obtain for unsecured loans.
A HELOC may be preferred for some renovation or home improvement projects. You could enjoy benefits to your home while at the same time offsetting the cost of some of the projects with improved market value.
Finally, you may benefit from potential tax savings of a HELOC. The interest on that loan plus interest paid on your primary mortgage are generally tax-deductible, thereby reducing the impact of interest paid on the loans.
Cons of HELOCs
HELOCs are not the magic solution that many homeowners think they are. You are essentially risking your most valuable asset by using it as collateral on a new loan. If you default on the HELOC, there are serious repercussions to your finances and credit profile.
Using HELOCs to pay off debt can also be dangerous. Studies have shown that 70% of homeowners who used HELOCs to pay off high interest credit card debt found themselves in far worse shape just 2 years later. Since they did not close the credit card accounts and never changed their overspending habits, they found themselves unable to pay the HELOC along with new maxed out credit card payments.
Home improvement projects normally cost more than the extra value that they generate. A $10,000 kitchen remodeling may only increase your home’s value by half that amount.
Drawing down the equity in your home is very much like returning a portion of the home in which you own back to the bank. This wealth stripping behavior can leave you without important options to sell your home if the need arises in the future.
A HELOC can be a useful option, especially if it replaces a higher interest loan that you intended to open. You just need to be careful to ensure that you are not risking your most valuable asset.