If you buy a house, there’s an excellent chance it will be the largest asset you own—maybe ever. I often stop and experience amazement that someone loaned me and my wife sufficient money to purchase a house—but we managed it, and then a few years after buying this place, a hurricane swept through and turned our first floor into an aquarium. As I stood there surveying the damp damage and wondered how we were going to pay for the mind-boggling repairs needed, I remembered we’d taken out a Home Equity Line of Credit (HELOC) when we bought the house—and it saved our butts.
A HELOC is different from a home equity loan—instead of a lump sum paid into your account with a (usually) fixed interest rate, HELOCs are open lines of credit that come with variable rates. They can sit dormant, meaning you can open one up and never use it, and they usually have a draw period between 10 and 15 years. And you only pay interest on the money you actually use from it. Here’s why you should have one ready to use.
Emergency funds
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A HELOC can make all the difference when an unexpected emergency hits. When people think about HELOCs, they mainly think about home renovations, which is how most HELOCs get used. This makes sense, as you’re borrowing from the value of your house in order to increase its value. But HELOCs can also be emergency buffer funds that can help you financially survive an emergency.
When our house was smashed by that hurricane, we knew the costs to tear everything out, treat for mold, and then put everything back—and I mean everything, down to the floors—was going to be astronomical. We had flood insurance, but it took months to get a check from that. Our HELOC allowed us to get started on mold remediation immediately, and our house was repaired in just two months because we didn’t have to wait on an insurer. Meanwhile, we didn’t have to drain our savings account while we waited on insurance payouts.
It’s crucial to have a HELOC ready to go—setting up a HELOC is like setting up any other loan, and the process can take months, which won’t do you any good when you’re dealing with an emergency. Since you don’t have to access your HELOC—ever—you can have that line of credit sitting there and pay nothing for it until you actually have to use it. And interest rates on HELOCs are typically lower than home equity loans because you’re putting your house up as collateral, so there’s less risk for your lender (more on that in a moment). And since you only pay interest on the amount you actually use, it can be a very precise financial instrument—and it’s not just for disasters. You can draw on a HELOC for anything you lack immediate funds for, like medical emergencies, unexpected unemployment, or surprise home repairs.
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The downsides
While having a HELOC on hand is a good idea to ride out unexpected financial disasters, there are a few things to consider:
Risk. You should only use your HELOC funds as a kind of “bridge loan”—like in my personal example, when we used it while waiting on an insurance settlement we were sure was coming—and only when you need to move quickly. Your house is collateral on a HELOC, so if you default the lender, can foreclose. If you have time, a personal loan or other form of credit is a less-risky choice.
Rates. HELOCs are typically variable-rate loans, so your monthly payments may change suddenly. Even if you’re comfortable carrying the debt, you may end up paying more for your loan than you expected.
Term. Most HELOCs are split into two terms. Initially, they are credit lines you can draw on whenever you want (called the “draw period”). After that term ends (usually 10-15 years), they enter the “repayment period.” You can no longer draw on them, but you do have to pay back the principal plus monthly interest. That’s why it’s a bad idea to use a HELOC unless you know you can pay it back relatively quickly—otherwise it can turn into a substantial debt. And—again—your house is on the line.
That being said, having a line of credit ready to go can make all the difference when an emergency strikes. Being able to lay out substantial sums of money without delay can be the difference between a quick recovery and ongoing misery. Just be certain you’re not getting in over your head.