When tackling projects or facing large expenses, homeowners who have built up equity in their homes often turn to a home equity line of credit (HELOC) to finance the costs. If you’ve already got a HELOC, knowing how it works and using it well can be an appropriate way to meet your goals. And depending on how you use it, there could be tax advantages, too.
The Most Common Uses for HELOC Loans
HELOCs make it easy to put your home equity to work for you. HELOCs work by letting you tap your HELOC whenever you need it during the draw period, which is generally the first 10 years after you close on the loan. And if you’ve paid down the principal, you can draw on a HELOC again.
Common uses for HELOCs include home improvements, college tuition, and emergencies. Debt consolidation can also make sense, provided you’re paying off higher-interest debt and replacing it with lower-cost debt.
HELOCs are as easy to use as a credit card—but it’s important to remember that’s not what they are. A credit card is an unsecured debt, backed by the strength of your credit rating. When you use your HELOC, you’re borrowing against your home, so you need to be confident in your ability to manage and repay this type of debt.
The Purpose of HELOC Loans
Once your home equity line of credit has been approved, there’s technically no limit to what you can use it for. Whether you should use it for those purposes is a separate question.
“Because a home often is a consumer’s most valuable asset, many homeowners use home equity credit lines only for major items, such as education, home improvements, or medical bills, and choose not to use them for day-to-day expenses,” the Consumer Financial Protection Bureau has noted in its consumer guide to HELOCs.
Financial planners frequently advise customers to consider using their HELOC to finance home improvements that will increase the home’s value.
“You may also find that a HELOC is helpful when it comes to paying for college, as long as the interest rate is lower than student loan interest,” said Michael Foguth, founder of Foguth Financial Group, a financial planning firm in Brighton, Michigan.
“A HELOC can also be used for emergency expenses that you didn’t foresee and plan for,” Foguth adds. “It’s important to be careful when using a HELOC for anything other than home improvements, as if you’re not diligent in paying back the HELOC, you could put your home at risk.”
On the other hand, it’s not advisable to use a HELOC if it’s going to put you in more debt that you can’t afford, Foguth said. “As an example, avoid using a HELOC on vacations, new car/recreational vehicles or weddings,” he explained.
Taxes and HELOCs
Many people remember when the interest on HELOCs was fully tax deductible, but that is no longer the case. If tax deductibility is important to you, be aware that since 2017, federal law has limited what qualifies as a home equity deduction.
Interest on a home equity loan or line of credit is deductible only if the debt was used to “buy, build, or substantially improve your home,” according to IRS regulations. If you borrowed for any other reason, you can no longer deduct the interest.
How Many Homeowners Use HELOCs
People who have HELOCs tend to use them. Only 27 percent of customers with a HELOC had a zero balance at the end of 2019; 7 percent had utilized their entire available HELOC funding, and the other 66 percent were somewhere in between.
On average, HELOC customers used 44 percent of their available lines of credit during 2019, according to the Mortgage Bankers Association of America.
The Bottom Line
Your home is not a piggy back. But it is a cornerstone of your wealth, and HELOC, when used prudently, can be an efficient way of tapping your built-up equity. Make sure you understand your loan, the repayment terms, the potential tax implications, and the risks.