Should You Ever Take Out a Home Equity Line of Credit?

Should You Ever Take Out a Home Equity Line of Credit?

In our “Ask a CFP®” Q&A series, we cede the floor to a CFP® who will address some of the trickiest money topics out there.

Today, Matt Shapiro, CFP®, a financial planner with LearnVest Planning Services, discusses when it is—and isn't—wise to use a Home Equity Line of Credit (HELOC).

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Owning a home can often mean wading through an alphabet soup of real estate terms. One acronym that creates particular confusion? HELOC.

This is a line of credit that's secured by your home, so the more equity you have in your home, the more credit you qualify for.

But unlike a conventional loan, in which you're given a lump sum, a HELOC works more like a credit card—if you don't spend the money, you don't pay any interest. 

Still, there's a lot of misunderstanding over how HELOCs should really be used.

Should I Ever Take Out a Home Equity Line of Credit?

Why So Many People Ask This Question: Compared to credit cards, HELOCs tend to offer favorable interest rates, and they generally come with higher credit limits.

Translation: Many people see HELOCs as a low-cost way to finance big-ticket expenses, such as college tuition, a home renovation or medical costs.

But in my conversations with clients, it's not uncommon for HELOCs to be mistaken for emergency funds—not to mention that people start to treat their homes like bank machines. Since HELOC lenders often give people an ATM card to use, it's easy for them to forget they're spending money they don't have.

And that’s where HELOCs can become dangerous.

What I Tell Them: In almost all situations, I recommend clients build up a dedicated emergency fund and save for specific goals—such as college costs—before resorting to a HELOC.

That’s because you’ll always end up paying more over the long run—while also putting your house at risk because you're using it as collateral. Plus, HELOCs typically come with variable interest rates. So while it may seem low now, your rate could end up increasing to more than you can afford.

Still, there are some scenarios when a HELOC might make sense.

For example, if you're planning a $20K renovation that will likely up the value of your property before you put it on the market, a HELOC could be a good idea. But again, this is only if saving up first isn't an option.

Or, in some cases, a HELOC could be useful to someone paying down high-interest credit card debt. Of course, here's the big caveat: If you're a chronic overspender, it's important to solve those underlying problems first—before even considering taking out a HELOC.

The Bottom Line: Nine times out of 10, it's better to save up for an expense instead of taking out a HELOC. But if you are considering one, talk to a financial adviser before making a decision.

RELATED: Home-Buying Guide: 5 Ways to Prep Your Finances Before Signing on the Dotted Line

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

LearnVest Planning Services is a registered investment adviser and subsidiary of LearnVest, Inc., that provides financial plans for its clients. Information shown is for illustrative purposes only and is not intended as investment, legal or tax planning advice. Please consult a financial adviser, attorney or tax specialist for advice specific to your financial situation. Unless specifically identified as such, the individuals interviewed or quoted in this piece are neither clients, employees nor affiliates of LearnVest Planning Services, and the views expressed are their own. LearnVest Planning Services and any third parties listed, linked to or otherwise appearing in this message are separate and unaffiliated and are not responsible for each other’s products, services or policies.

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