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What Is a Home Equity Line of Credit

Key Takeaways

  • A HELOC is a line of credit that uses your home as collateral.
  • An important thing to remember about a HELOC is that the interest rate is variable and adjusts with prime rate.
  • Under the new tax bill, if you use your line of credit to make improvements on your home, the interest you pay may be tax deductible.

A HELOC is a line of credit that uses your home as collateral. The amount you can borrow is based on the value of your home minus any mortgage(s) you may have. As you pay off your mortgage - your home gains equity which you can then leverage via a HELOC to fund your dreams, like a home renovation. It can also be used for other uses like debt consolidation, emergency funds, funding education, or as an alternative to a personal loan. A HELOC often has a lower interest rate than other financing options, so it can be a big advantage for homeowners. A HELOC interest rate is variable and adjusts with the Prime Rate.

How a HELOC works

A HELOC works similar to a credit card in that you are approved for a set amount of credit to use (based on the equity in your home), but you do not have to use it all at one time, as you would for a home equity loan. The credit is available to you over the borrowing or draw period, typically 10 years. You can easily access the money by writing a check, transferring money through online banking, or even via your mobile banking app.

During the borrowing period you can take out either small amounts or a larger lump sum — it’s up to you (and your credit limit). You’re only required to make monthly interest payments on the money that you actually borrow — not on the entire credit line. Of course, you can pay more to repay your debt faster without penalty.

After the draw period is over, the repayment period begins. The repayment period length may vary by lender and could be anywhere from 10 to 20 years. Research those options and find out what best fits your needs as at this point you’ll be making both interest and principal payments. The important thing to remember about a HELOC is the interest rate is variable and adjusts with the prime rate, which means the amount of interest you pay could fluctuate up or down following interest rate trends over the course of the draw and repayment period.

What you can use a HELOC for

A HELOC is similar to having a credit card with a large limit. Essentially you can use the money for whatever you want, such as debt consolidation, or paying for college. However, exercise caution: just because you can, doesn’t mean you should.

Three great reasons to use a HELOC are:

  • Home Improvement. Under the new tax bill, if you use your line of credit to make improvements on your home, the interest you pay may be tax deductible. Talk to a tax professional first, as that indoor bowling alley may not qualify.
  • Education. A HELOC can be an excellent way to pay for for your or your child’s education. You can borrow against your line as tuition payments come due and you can use it for multiple years and for multiple children. Interest rates on HELOCs are often lower than other student loan types.
  • Safety Net. If your emergency fund has been depleted, or you don’t have a substantial savings account, having an open HELOC may give you peace of mind. Life happens, whether we’re prepared or not. While you’re busy building your “just in case” fund you can always tap your HELOC when your water heater decides to stop working in the dead of winter. Once again, you only pay interest on what you withdraw.

When you should avoid using a HELOC

Using your home equity puts your home on the line — if you fail to pay it back, you could lose your home (as your home is held as collateral). It’s important to use your credit wisely and not be tempted to treat your home like an ATM. Most homeowners limit borrowing on their HELOC to important purchases that add value to their life or help them manage their finances. Replacing a leaky roof is a great way to use a HELOC, as it’s a large and necessary expense. Although a cruise around the world sounds amazing, it might not be the best way to use it.

What to remember

A HELOC can be an attractive asset for homeowners, providing financial flexibility to help you achieve your dreams. However, there are many ways to tap into your home’s equity; weigh your options to find what’s right for you and your financial plan.

More Information

We are committed to helping you reach your potential by providing personalized solutions. Our dedicated colleagues can help you find the right product to reach your goals. Learn how to put your home equity to work for you online or Ask a Citizen at your nearest Citizens Bank branch or call us at 1-888-514-2300.

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