It may come as something of a surprise, but a reported 90 percent of homeowners plan some form of upgrade to their home. Most anticipate making home improvements within the next 24 months, and that often requires borrowing from a lender.
A home equity line of credit, also known as a HELOC, has emerged as a go-to option for homeowners wanting everything from expansive kitchens to a new roof. But deciding which line of credit or loan product makes sense for your home improvement project can be complicated.
By understanding what a HELOC is, as well as the pros and cons of using it to finance your home improvement project, you can rest easy knowing you will make an informed financial decision.
What is a HELOC?
A home equity line of credit — commonly referred to as a HELOC— allows homeowners to borrow money against the largest investment many of us make, our house. As homeowners pay down the mortgage and property values increase, the growing equity emerges as an asset.
Equity ranks among a homeowner's top resources in terms of borrowing power. Lending institutions recognize equity as a way to secure products such as a HELOC. But there are significant differences between taking out a HELOC and other loan products.
A HELOC can act much like a credit card with a borrowing limit. In many cases, homeowners can utilize the funds and pay the line of credit down and tap the resource again.
Once a homeowner has been approved for a HELOC, your lender may set a time period for withdrawals. When the withdrawal date passes, borrowers start repayment on the total amount used. In some cases, lenders may adjust or extend the withdrawal and borrowing periods. Some products enjoy an overlap of repayment and withdrawal, making them increasingly flexible.
As you can see, home equity lines of credit are structured differently from other financial alternatives, like personal loans.
5 Pros of Using a HELOC for Home Improvements
Qualifying borrowers can typically get a home equity line of credit and borrow up to 90 percent of the home’s overall value. Line of credit products can be blessings for cash-strapped property owners with substantial equity. These rank among the top benefits of leveraging a HELOC:
- Tax Deductible – When a HELOC is used to make home improvements, the interest you pay usually qualifies as a tax-deductible expense. Be sure to consult a tax advisor for your specific situation.
- Flexible Borrowing – Many other loan products require taking out a lump sum and promptly beginning repayment. A HELOC allows borrowers to withdraw only the specific amount they need. If your project runs under budget, you will not pay interest on unused funds.
- Easy Access – Borrow from your HELOC easily with access typically offered through a check, transfer, or credit card linked to the account.
- Easy Application Process – Applying for a HELOC can be done in minutes with the right lender. Credit unions typically make the decisions locally offering a faster approval process.
- Debt Consolidation – If you finish your project ahead of schedule and have some money left over, consider debt consolidation. Use the remaining money in your HELOC to consolidate any high-interest debt to save you money. Consider the disparity between some credit card interest rates and a HELOC to see if consolidation makes fiscal sense.
Homeowners often prefer securing a HELOC due to its flexibility. Another benefit to consider, like other products, consistent repayment can help improve credit scores. Even with all the positive benefits HELOCs offer, it is important to understand and consider all the aspects this and other borrowing options offer to make informed financial decisions.
5 Cons of Using a HELOC for Home Improvements
It’s essential to understand that the perfect loan or line of credit does not necessarily exist. A HELOC has proven benefits, but you need to keep the following elements in mind:
- Collateral Risk – A home equity line of credit involves leveraging your home as collateral. While homeowners generally breeze through the withdrawal and repayment process, you are taking a calculated risk. Some people are uncomfortable leveraging their homes in this way.
- Equity Can Fluctuate – Home and property values can drop quickly causing homeowners to be “underwater” (when they owe more than their home is worth). Be sure you borrow only what you need and confirm the home improvements you are making will increase the value of your home.
- Interest Rates Increase – Interest rates are always changing. The repayment on an adjustable-rate HELOC could rise should interest rates increase.
- Payment Surprise – Interest-only payments for the draw period can be typical for HELOCs, but if you only plan on making these minimum payments, your principal balance won’t be touched. When the repayment period begins, you may be surprised at the total payment due each month. To stay on top of this, make sure you are keeping track of your total expenses and keeping in mind both the interest and principal portion of your upcoming payments.
- Need to Sell – If you have a HELOC and unexpectedly need to sell your home, you will typically need to clear that debt at or before the closing. This may leave you with less cash on hand.
Visit any of our branch locations or apply online for a Home Equity Line of Credit at CCCU.