When Does It Make Sense to Use a Home Equity Line of Credit (HELOC)?

When you buy a house using a mortgage, the amount of equity you own in your home initially depends on the size of your down payment. If you put 20 percent down on your home, for example, you own 20 percent of your home at the start of your loan.  

Over time, the amount of equity you have in your home increases as you make your monthly payments and reduce your mortgage balance. At some point, you may consider using the equity in your home to help you with a few financial goals. For many people, that involves opening a home equity line of credit (HELOC). 

A HELOC is exactly what it sounds like: A line of credit that homeowners can use to access the equity that they’ve built in their home. But unlike credit cards and most other lines of credit, HELOCs are what’s known as secured debt, meaning it’s backed by some sort of property. This means that your home is essentially a form of collateral on the debt so if you default, in a worst-case scenario the bank that issued the HELOC could try to force a foreclosure. 

Because HELOCs are backed by your home, they typically carry lower interest rates than other forms of debt. This makes them very attractive to homeowners who are looking to put their equity to work. But when does it make sense to tap a HELOC? Here are a few things to consider.  

When it might make sense to use a HELOC 

When interest rates are low or declining 

Most HELOCs have variable interest rates, which means that they fluctuate depending on the underlying federal funds rate. This makes HELOCs particularly beneficial during periods of low or declining rates.  

But low rates today don’t necessarily mean low rates throughout the life of the HELOC. It’s important to think about how rising rates might impact your ability to repay the debt. Consider the maximum possible interest rate (which should be disclosed in your paperwork) before borrowing. 

If you’re using the money to make home improvements 

Tapping a HELOC to improve your home in some way — for example, to pay for a renovation or necessary repair — can be a smart way to utilize your home equity. That’s because these types of expenses have the potential to increase the value of your home. 

As an added bonus, you may be able to write off all or a portion of the interest you pay toward your HELOC come tax season if you used the money to “buy, build or substantially improve” your home, according to the IRS. Speak with a tax professional to confirm whether your home improvement project qualifies for a tax break.  

In the event of an emergency 

An emergency fund that holds six months’ worth of expenses should be your first line of defense against an unexpected cost that can throw your budget out of whack. But if you’ve depleted your emergency savings and are considering using a credit card, a HELOC may be a better alternative. That’s because it will most likely charge a lower interest rate than a credit card. Just make sure that you have a plan to pay off the debt. 

When it might not make sense to use a HELOC 

When you’re trying to consolidate unsecured debts 

Because HELOCs typically come with lower interest rates than credit cards, many people find it tempting to use a HELOC to consolidate the more expensive, unsecured forms of debt they’ve accumulated from credit cards or personal loans.  

This can be risky. Paying off a large amount of unsecured debt using a HELOC means you are essentially putting up your home as collateral for that debt. If you’re unable to make your payments, you risk losing your home. It may make more sense to come up with a plan to prioritize paying down those debts instead and start building some good credit card habits to avoid more debt.  

When you need to cover everyday expenses 

If you are tempted to tap your home equity to cover everyday expenses, think twice. If you’re having trouble making ends meet, the last thing you want is to put your home at risk by leveraging a HELOC to cover living costs. Instead, reevaluate your budget and find opportunities to cut costs or bring in additional income so that you don’t need to rely on debt for your basic expenses.  

To fund a large expense or purchase not related to your home 

Using a HELOC to make large purchases that you would not otherwise be able to afford — like a vacation, new car or educational expenses for your child — isn’t a great idea. These aren't increasing your wealth or the value of your home, so you’re ultimately risking your home to cover costs that you should be budgeting for instead. Often, there are other financing options, such as a car loan or student loans, that would be better suited for those types of purchases. If you have bigger financial goals you’re trying to meet, consider talking to a financial advisor to discuss how you can save for those goals without having to go into debt.