What’s the Best Strategy for Using a HELOC?

Unlocking the equity in your home with a home equity line of credit (HELOC) can be a smart way to finance large expenses or pay off debt. But without a solid HELOC strategy, it’s easy to get in over your head. 

You may have heard of using a HELOC to pay off your mortgage, but other ways exist to leverage your equity. Below, we’ll explore the best HELOC strategies and which one might be right for you.

In this guide:

• What is the best HELOC strategy?
• Tax implications of implementing a HELOC strategy
• How to choose the right HELOC lender
• What not to use a HELOC for
• FAQ

What is the best HELOC strategy?

A HELOC is a revolving line of credit that allows you to borrow money based on the equity in your home, which is your home’s value minus your remaining mortgage balance. A HELOC is like a credit card. You can borrow up to a certain limit, and you only pay interest on what you use. 

HELOCs often have lower interest rates than credit cards and personal loans because they’re backed by your house. But the rate is usually variable, so your monthly payment can go up and down over time.

You can use the money from a HELOC for almost anything — home renovations, debt consolidation, medical expenses, and even a wedding. But the real benefit comes from using your HELOC to reach other financial goals. 

Let’s explore some of the best HELOC strategies and whether Jim McCarthy, CFP®, whom we consulted, recommends them. You can click on each strategy in the table to read more details about it below.

Strategy	CFP® recommends?
Pay off your mortgage	❌
Increase home value	✔️ (in certain situations)
Pay off debt	✔️ (if debt has a higher interest rate and you commit to no longer amassing debt)
Establish an emergency fund	✔️
Invest	❌

HELOC strategy 1: Pay off your mortgage

The first and most common strategy is to use your HELOC to pay off your mortgage. 

If you’re approved for a line of credit sufficient enough to cover your remaining mortgage balance, you could use the money to pay off your mortgage. 

During the HELOC’s draw period (often 10 years), you have two options:

1. Make interest-only payments and redirect your extra cash flow toward other financial goals, such as saving for retirement, building an emergency fund or investing in your children’s education. 
2. Continue making your same mortgage payment and—ideally—pay your loan off faster. 

Advantages

A significant benefit of using a HELOC to pay off your mortgage is saving money on interest payments if you qualify for a lower rate. Plus, you have the flexibility to redirect your savings toward other priorities.

HELOCs often have lower fees than refinancing, so if your remaining balance is relatively low, it can be a solid way to get a lower rate. 

Risks

HELOC interest rates can change over time as the prime interest rate shifts if you have a variable rate (which is common with HELOCs). You might start out with a lower rate, but it isn’t guaranteed to stay there.

Another risk is that your mortgage payment may include property taxes and home insurance, which your HELOC won’t. Budgeting for these expenses on your own might be a challenge if you’re used to paying them as part of your mortgage payment. 

Some homeowners can deduct their mortgage interest payments from their tax return. If you use your HELOC to pay off your mortgage, you’ll lose this benefit. 

Who is this strategy best for?

This strategy is best for homeowners who have significant equity in their home and a high interest rate on their mortgage. It can be an effective way to reduce your debt faster and save money on interest payments. 

HELOC strategy 2: Increase your home’s value

Another common HELOC strategy involves using the money for home improvements that could increase the value of your property. By using the HELOC for renovations or upgrades, you could increase your home’s resale value or make it more attractive to potential buyers.

Compared to other strategies on this list, using a HELOC to increase your home’s value is a long-term investment that can pay off in the future. 

Advantages

Renovations can increase the value of your home, meaning more money when you sell it. They can also make your home more comfortable to live in and improve your quality of life. 

Plus, if you use your HELOC funds to “substantially improve your home,” the interest you pay on the loan may be tax-deductible.

Risks

Renovations can be expensive, so it’s critical to have a solid plan for how you’ll use your HELOC funds before you start. If your improvements don’t add value to your home, you may end up with a higher mortgage payment but no corresponding increase in value.

You’ll also want to ensure you’re not over-improving your home. This can make it harder to recoup your investment when you sell. Over-improving means making changes to your home that are uncommon and costly for your neighborhood. 

Also, using your HELOC to take on more debt means you’ll have to make monthly payments on the loan, so ensure you can afford the added cost. 

Who is this strategy best for?

This strategy is best for homeowners committed to making improvements that will increase their home’s value. It can also be a suitable option if you plan to stay in your home for a while and want to make it more comfortable to live in. 

This strategy isn’t wise if you’re struggling to make your monthly mortgage payments or are already carrying high debt.

HELOC strategy 3: Pay off debt

If you have high-interest debt from credit cards, payday loans, or personal loans, using a HELOC to pay it off can be a wise move. HELOC interest rates tend to be lower than these types of debt, so you can save on interest with this strategy. 

Using a HELOC to pay off debt isn’t as fun or exciting as using it for home renovations, but it can help you get back on your feet if you’re struggling to keep up with high-interest debt payments. 

Advantages

One of the main advantages of using a HELOC to pay off debt is the potential for significant interest savings. HELOCs tend to have lower interest rates than credit cards and personal loans, so you can reduce your overall cost of borrowing. 

Also, consolidating your debt with a HELOC can simplify your finances by reducing the number of monthly payments you make. One monthly payment versus multiple can help lower your stress and reduce your chances of missing a payment.

Risks

The biggest risk of using a HELOC to pay off debt is that you’re trading unsecured debt for a secured debt. If you can’t make your HELOC payments, you could lose your home.

Also, if you use your HELOC to pay off your credit card balances, you risk racking up more debt if you’re tempted to overspend on your cards again. If you use this strategy, ensure you also work on building good spending habits so you’re not trapped in a cycle of debt. 

Who is this strategy best for?

This strategy is best for homeowners with high-interest debt and enough equity in their home to qualify for a HELOC. It’s also a good option if you want to simplify your finances by consolidating your debt into one monthly payment. 

“It makes sense to consider a HELOC to pay off higher-interest debts—with a  giant caveat: You must destroy all those credit cards.”

Jim McCarthy

CFP®

HELOC strategy 4: Establish an emergency fund

Another strategy involves using your HELOC as a backup emergency fund. If you lose your job or have an unexpected expense, you could draw from your HELOC funds and pay it back over time. 

This strategy is similar to using a credit card for emergencies, but with a HELOC, you’ll likely have a lower interest rate.

It’s wise to have a separate emergency fund in a high-yield savings account, so you don’t risk losing your home if you can’t make payments. Still, using a HELOC as an emergency fund can work in certain situations. 

Advantages

One advantage of using a HELOC as an emergency fund is accessing the funds quickly if you need them. You’ll only pay interest on the amount you use.

Risks

One risk of using a HELOC as an emergency fund is that you may be tempted to use it for nonemergency expenses, which could lead to more debt. You’ll also need to ensure you have a plan to pay back the money as soon as possible.

Who is this strategy best for?

This strategy is best for people concerned they don’t have sufficient savings and want to be prepared for emergencies. But if you think you’ll be tempted to spend your line of credit on nonemergencies—such as vacations or expensive toys—it may not be worth it. 

HELOC strategy 5: Invest

Another HELOC strategy involves using your line of credit to invest in real estate. This could include using your HELOC to cover a down payment on a new property, make renovations, or purchase a property outright. 

HELOC interest rates tend to be lower than other types of financing, so this can help you lower the overall cost of borrowing and potentially increase your return on investment.

But be careful with this strategy. It’s riskier than other options on our list because it involves taking on more debt, and returns aren’t guaranteed. Talk to a financial professional, and consider your financial goals and risk tolerance before using it.

Advantages

One benefit of using a HELOC to invest in real estate is helping you build long-term wealth, especially if you purchase a property that generates positive cash flow.

Risks

Using a HELOC to invest in real estate can be risky if the investment doesn’t pan out. Also, interest rates on HELOCs can be variable, meaning your monthly payment could increase if rates rise. If you borrow too much with your HELOC, you could over leverage yourself and put your finances at risk.

Who is this strategy best for?

This strategy might be suitable for homeowners with experience in real estate investing who are comfortable taking on the risks involved. Approach this strategy with caution. 

Our expert’s take

Jim McCarthy

CFP®

I generally recommend that all my clients establish a HELOC. It allows them to use the HELOC to cover emergencies or even home improvements instead of selling other investment assets when the financial markets make that undesirable. However, I would never recommend using a HELOC for investment or paying off a first mortgage.

Tax implications of implementing a HELOC strategy

The only way to get tax benefits from a HELOC is if you use the funds to “buy, build, or substantially improve your home,” according to the IRS. So if you use the HELOC to improve the home that secures the loan, you may be eligible for a tax deduction. 

If you use your HELOC to pay off debt, invest in real estate, or as an emergency fund, you won’t be able to deduct interest from your taxes.  

HELOC strategy	Tax-deductible?
Pay off mortgage	No
Increase your home’s value	Sometimes
Pay off debt	No
Establish an emergency fund	No
Invest in real estate	No

How to choose the right HELOC lender

The best way to choose a HELOC lender is to grab offers from at least three providers. Compare interest rates, fees, and the maximum loan-to-value (LTV) ratio accepted. Your LTV compares your mortgage balance to your home’s appraised value; it tells you how much equity you have. 

Also consider terms and draw and repayment period lengths. For example, if you plan to use your HELOC for home improvements over the next five years, you’ll want your draw period to be at least that long. Also, consider extra features you’d prefer, such as the ability to lock in your rate throughout your term.  

The HELOC strategy you plan to use may affect your choice of lender. Check out our list of the best HELOC lenders with competitive rates, low fees, and excellent customer service to help you get started.

What not to use a HELOC for

By law, you can’t use your HELOC funds to gamble or engage in other high-risk activities. But beyond this, you should think twice before using a HELOC for:

• Nonessential expenses. Using your HELOC for vacations, expensive electronics, jewelry, and gifts can leave you with significant debt that’s difficult to pay off.
• Buying a car. Auto loan interest rates tend to be more stable than HELOC interest rates, so we don’t recommend using a HELOC to buy a car.
• Paying off debt that has a lower interest rate than your HELOC. It doesn’t make sense to use your money to pay off debt that has a lower interest rate than your HELOC because you’ll pay more in interest in the long run.
• Any expense you can’t afford to repay. Always use your HELOC funds wisely because you risk taking on too much debt and defaulting on your home if you can’t make your payments.

FAQ

Can I use a HELOC to start a business?

Yes, you can use a HELOC to start a business, but be careful. Using your home as collateral for a business venture can be risky, and if the business fails and you default on your loan, your lender could take your house. If you decide to use a HELOC to start a business, ensure you have a well-thought-out plan in place and only borrow what you need.

Can I use a HELOC to pay for college?

Yes, it’s possible to use a HELOC to pay for college. But it’s best to exhaust all federal aid options first. HELOCs can have lower interest rates than private student loans, but they’re often not as low as federal loan rates. You can also make interest-only payments during the draw period, which can be more affordable. 

What are alternatives to a HELOC I should consider?

If you think a line of credit may not be right for you, HELOC alternatives to consider include: 

• Home equity loans: These are similar to HELOCs, but you get a lump sum and pay it back in fixed installments. 
• Personal loans: These have higher interest rates but no closing costs or risk of losing your home. 
• Home-sale leasebacks: This option lets you sell your home and continue living there, but you’ll no longer own your home and must pay rent. 
• Cash-out refinancing: This can be a worthwhile option if you’re eligible for lower rates than you’re paying on your mortgage. 

What happens if the housing market crashes? Will it affect my HELOC?

If the housing market crashes, it could affect your HELOC. During the 2009 housing market crash, some lenders froze credit limits on open HELOCs, which made it difficult for homeowners to access their available credit. Also, many homeowners couldn’t make their payments and lost their homes to foreclosure. 

What are the risks of using a HELOC to achieve other financial goals?

The most significant risk of using a HELOC involves the lender foreclosing on your home if you take on more debt than you can handle or your payments balloon due to rising interest rates. As you factor in the cost of your HELOC, look for the maximum interest rate your lender can charge, and ask yourself if you could afford that payment.