June 10th, 2014

How Can I Use a HELOC This Spring?

With low interest rates, flexible repayment terms, and potential tax benefits, a home equity line of credit (HELOC) could be a great way to pay for important expenses, like home improvements or college tuition, and could be a money-saving way to consolidate other debt.

What is a HELOC?

A HELOC is a revolving line of credit that allows you to borrow against the equity you’ve built up in your home. It works a bit like a credit card. You borrow what you need, up to your available credit line. As you repay what you’ve borrowed, that amount is available to you again when you need it.

For example, if you get approved for a HELOC with a limit of $20,000, you’ll be able to borrow up to that amount, but you don’t actually have to borrow the full amount. You will then have to pay back what you use at a variable interest rate. So, if you get approved for a HELOC of up to $50,000, and use just $5,000, you will only have to pay interest on the $5,000 you’ve borrowed.

You can typically make advances from your HELOC for the first 10 years (the draw period). You’ll make payments based on the amount you borrow, often a percentage of the outstanding amount. Once the draw period ends, the HELOC converts to a fixed-term loan, and you pay back any outstanding principal over a set number of years (the repayment period).

A HELOC is very different from your other option, a home equity loan (HEL). With a HEL, you receive a lump sum of money when the loan closes and immediately begin making monthly payments.

A HEL is a better option for if you know exactly how much money you will need to borrow and want the security of fixed payments and a set maturity date.

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Why should I get a HELOC?

The terms on a HELOC are likely to be much better than the terms on your other options, which include credit cards and personal loans.

First, since you are using your home as collateral for the loan, the interest rate you receive on a HELOC is likely to be far lower than any rate on a credit card. The average annual percentage rate (APR) on a credit card is just over 12%, while the average APR on a HELOC is just over 4%, according to the NCUA.

Some lenders also offer an initial repayment period with a low, fixed-rate APR, saving you more money on interest. Keep in mind that the actual rate you receive will depend on a number of factors, including your credit score.

There is also a potential tax benefit for using a HELOC. The IRS allows you to deduct home equity debt interest as an itemized deduction as long as the debt is secured by your home. You can deduct interest on home equity debt up to $100,000 if you are single and $50,000 if you are married filing separately. You should consult with a tax advisor regarding the deductibility of interest on a HELOC1.

What can you use a HELOC for?

What you do with the money is entirely up to you. Here are some potential uses for your HELOC:

  • Make home improvements that increase the value and the comfort of your home. Whether it’s a bathroom or kitchen remodel, new hardwood flooring, refinishing an outdoor deck, or replacing the roof or windows, the choice is yours.
  • Pay college tuition or unexpected expenses such as medical bills or car repairs.
  • Consolidate high-interest debt. This could end up saving you a hundreds or even thousands in interest payments.

With a lower interest rate than your other options, potential tax advantages, and convenient access of funds, using a HELOC can be a smart move this spring.

Steve Nicastro, NerdWallet

1Seattle Metropolitan is not a tax advisor and does not offer tax advice. Consult your tax advisor regarding your personal tax situation.

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