The average homeowner with a mortgage ended 2023 with $299,000 in home equity, according to ICE Mortgage Monitor, which also estimates that the average funds homeowners could tap by borrowing against their home equity is $193,000.
Obviously, that number varies for each individual and depends on factors such as the original down payment, local property values, and the amount of time in the home. But if you have more than 20% equity in your home, using a home equity line of credit (HELOC) to build wealth is a strategy to consider.
Ways to Build Wealth With a HELOC
A home equity line of credit lets you borrow funds as needed (up to a prearranged limit) through a credit draw. This is different from a home equity loan, in which you would borrow a one-time sum of cash. Drawing on your home equity for certain expenses could help grow your wealth over time, if it financially makes sense. Here are some options to consider.
1. Home Improvements
A HELOC works well for larger home improvement projects and renovations because you can draw funds to pay for materials and contractors as needed. You accrue interest only on the outstanding balance, so it could be cheaper to opt for a HELOC vs. a home equity loan. And if you itemize your taxes, you could deduct HELOC interest payments when the money is used to improve the home.
Plus, a renovation project could build wealth by increasing the value of your home. Home improvement experts estimate that a kitchen refresh could deliver a 377% return on investment and refinishing hardwood floors could have a 348% ROI.
2. Debt Consolidation
You can’t deduct HELOC interest when you use the funds to consolidate debt, but you could still build your wealth. Paying off debt with a lower interest rate could save you a lot of money over the long run. Let’s look at an example.
Say you qualify for a HELOC with an 8% APR but you have a $10,000 credit card balance with a 22% APR. In order to pay off that card in five years, you’d pay $276.19 per month and pay $6,571.35 in interest.
With the HELOC, on the other hand, let’s say you made interest-only payments for one year, then spread out the principal and remaining interest over four years, for a total of five years. During the interest-only period, your payment would be $66.67, followed by $244.13 for the remaining four years. On top of that, you’d only pay a total of $2,518.19 in interest for the entire five years. That’s a potential savings of $4,053.16 in interest payments by consolidating to a lower rate!
3. Real Estate Investments
Using a HELOC to finance an investment property can help you start climbing the real estate ladder. Homeowners could use the funds to make a down payment, cover closing costs, and/or make some upgrades before renting out the property.
You’ll still need to qualify for the new property’s monthly mortgage loan payments, particularly if there isn’t a current rental income history for the lender to review. Assuming you’re eligible for the loan, the goal is to use the rental income to pay off the HELOC and make a profit. On top of that, the property itself could increase in value over time, building your overall wealth.
4. Education and Skills Development
Investing your home equity in your education or skills development could increase your earning power and, consequently, your wealth. Research shows that people with advanced degrees tend to earn more than those without them.
For instance, a study published in Demography revealed that women with bachelor’s degrees earn $630,000 more in a lifetime than those with a high school degree. For men, the increase in lifetime earnings is $900,000. The numbers are even more dramatic with graduate degrees. Women’s lifetime earnings are $1.1 million higher than their high school graduate counterparts, whereas men earn $1.5 million more. Clearly, investing in your professional skills can translate into greater wealth.
5. Start or Expand a Business
The majority of small business owners invest their personal funds in the growth of their companies. Research also shows that upfront funding correlates with greater revenue. So while there’s no way to know that home equity financing you use for your business will guarantee success, it could improve your odds to scale more quickly.
6. Investment Portfolio Growth
Growing a diversified investment portfolio is another option for using a HELOC to build wealth. Obviously, there is risk involved when funding investments. Focusing on long-term investments could help reduce the risk of short-term market volatility. Remember, though, that for investments made with money from a HELOC to truly pay off, you would have to earn more on the investment than you pay in interest for the HELOC.
7. Emergency Fund or Cash Reserve
Most financial experts recommend having three to six month’s worth of savings on hand in cash in case you lose a job or the ability to earn an income. However, the economic volatility that came during the pandemic has people rethinking that number and even recommending up to a year of expenses in savings. Using a type of home equity loan like a HELOC could give you the peace of mind of having a financial cushion to fall back on, while allowing you to carefully invest that six months of savings instead of keeping it in cash.
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What to Consider Before Getting a HELOC
There are several factors to consider before you decide on a HELOC instead of some other type of financing, such as a cash-out refinance or unsecured personal line of credit.
• Your home is used as collateral: In other words, if you default on your HELOC payments, you could lose your house.
• You must maintain 10% to 20% equity in your home: You can’t tap into your entire equity amount; lenders require you to keep some, which means you may not be able to borrow as much as you originally thought.
• Rates are usually variable: Your interest won’t stay the same and could increase if rates rise. That could mean a bigger balance and bigger payments down the road.
• HELOCs have two stages: The first is the draw period, in which you only have to make interest payments. After the draw period, you’ll make payments on both principal and interest.
Pros and Cons of Taking Equity Out of Your Home
It’s certainly possible to build wealth using a HELOC, but there are advantages and disadvantages to think about.
Pros:
• Low interest rate compared to other financing
• Interest accrues only on the balance, not available credit
• Borrow again when you replenish the credit line
• No restrictions on how you use the money you borrow
Cons:
• Home is used as collateral, putting it at risk
• Payment amount increases after draw period is over
• May come with closing costs and maintenance fees
The Takeaway
Tapping into your home equity using a HELOC is one way to potentially build wealth, especially because rates tend to be low when compared to other forms of borrowing. It’s always worth weighing the pros and cons, since defaulting on payments could result in losing your house. But if you have the financial confidence to move forward, there are several ways that your home equity could help you build wealth.
SoFi now offers flexible HELOCs. Our HELOC options allow you to access up to 90% of your home’s value, or $500,000, at competitively low rates. And the application process is quick and convenient.
FAQ
Is it smart to use a HELOC for investment property?
Using a HELOC for an investment property could help you fund the transaction sooner than if you used other types of financing. You may be able to make a bigger down payment or even make an all-cash offer. Just be sure that you feel confident in your real estate market research and your ability to make payments even if a worst-case scenario occurs.
What should you not use a HELOC for?
A HELOC should not be used for depreciating assets, especially when your goal is to build wealth. Things like vacations and car purchases aren’t usually recommended since they don’t hold their financial value.
What are the pitfalls of a HELOC?
The biggest pitfall is that your home is used as collateral to secure a HELOC and can go into foreclosure if you miss payments. On top of that, variable interest rates result in the potential for larger-than-expected payments if rates increase over time.
Photo credit: iStock/nortonrsx
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