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A home equity line of credit (HELOC) allows you to tap into the equity in your home, so you have convenient access to cash when you need it. Equity is the difference between what you owe on your home and its worth.
A home equity line of credit on standby could provide cash in an emergency. Unlike a home equity loan, you’d only pay interest on the part of the credit line you use. You don’t owe anything on a HELOC until you draw funds.
Should you get a HELOC, even if you don’t need the money right now? Weighing the pros and cons can help you decide.
In this guide:
- What are the benefits of having a HELOC just in case?
- What are the downsides to having a HELOC just in case?
- If I get a HELOC just in case, what can I do with the money?
- How long can I keep a HELOC open without using it?
- What happens if I get a HELOC just in case but don’t use it?
- How long do I need to be in my home to qualify for a HELOC?
- How to get a HELOC
What are the benefits of having a HELOC just in case?
HELOC originations increased 40.6% year over year through the second quarter of 2022, according to data from TransUnion. And while it’s unclear how many homeowners took out HELOCs for emergency purposes, we can assume some borrowers used their credit lines for unexpected expenses.
A HELOC can be helpful in an emergency because it’s a revolving credit line you can borrow against as needed. After a typical initial draw period of five to 10 years, you repay what you borrowed with interest over 20 years, in many cases. And if you never need to touch your credit line, you never pay interest.
Once you apply for a HELOC, it can take a few weeks to a few months to get approved. If you need cash right away, you may not have time to wait for lender approval on a loan or line of credit, so having a home equity line of credit ahead of time can help you prepare.
Other benefits of getting a HELOC just in case include the following:
- Convenient access. Depending on the lender, you might be able to draw from your credit line using a debit card, paper checks, or transfers to a linked bank account.
- Higher credit limits. You may be able to borrow more with a HELOC than a credit card or personal loan, depending on how much equity you have in your home.
- Interest rates. Although many HELOC rates are variable, they are often lower than the double-digit annual percentage rates (APRs) on credit cards.
- Fixed-rate option. Certain lenders offer a fixed-rate option for a HELOC, which allows for predictability with repayment.
- Flexibility. While you might open a HELOC for emergencies, you could also use it for other needs.
What are the downsides to having a HELOC just in case?
A home equity line of credit is similar to a credit card in terms of how it works. Both are revolving credit lines.
But a HELOC is different in two key respects:
- It may require you to pay upfront or annual fees, including closing costs and maintenance fees.
- While credit cards are unsecured, your home secures a HELOC.
Typical HELOC closing costs are 2% to 5% of your credit line, regardless of how much of the credit limit you use. You’ll pay the cost upfront, and your lender may charge an annual maintenance fee to keep your credit line open if you don’t use it.
But the more significant downside is foreclosure risk. If you use part of your HELOC to cover an emergency and then default on repayment, you could lose your home to foreclosure.
Are there other drawbacks to getting a HELOC just in case?
In some cases, the challenges include the following:
- Rate fluctuations. If the variable rate on your HELOC increases, any outstanding balance will result in more interest. While some lenders offer fixed-rate HELOCs, you may be subject to an initial 12-month variable rate.
- Minimum draw requirements. Lenders may require a minimum draw once you open your line of credit. For example, you may need to withdraw $10,000 right away, regardless of whether you have an emergency. You must then pay it back with interest.
- Potential for overspending. You might get a HELOC, but you risk the temptation to dip into it and create unnecessary debt.
- Suspension or reduction. Lenders can review your HELOC and reduce your credit line or suspend it if they see a significant change to your home’s value, creditworthiness, or ability to pay.
If you only plan to use your HELOC for emergencies, it’s essential to read the fine print, so there’s no room for surprises should you find yourself in an emergency.
If I get a HELOC just in case, what can I do with the money?
HELOCs are flexible. You can spend the money on whatever you need. Remember: The debt could put your home at risk of foreclosure if you can’t repay your credit line.
Does that mean you should avoid HELOCs for non-emergencies? Not necessarily, if you’re using the money to fund a specific goal or outcome that can offer a financial benefit.
For example, the IRS allows you to deduct HELOC and home equity loan interest when you use the proceeds to “build, buy, or substantially improve” the property that secures the loan. Likewise, using a HELOC to consolidate debt could save you money if you can repay it at a lower interest rate.
If you’re considering taking out a HELOC just in case, it’s important to define an “emergency expense.” You can avoid unnecessary use of your credit line. Common scenarios in which you might turn to a HELOC include the following:
|Emergency uses for a HELOC||Non-emergency uses for a HELOC|
|Unexpected medical bills resulting from an illness, injury, or temporary disability.|
Day-to-day living expenses if you lose your job or get laid off for an extended time.
Emergency home repairs not covered by your homeowners insurance.
Unexpected veterinary bills if a pet is ill or injured.
Family emergencies that require you to travel or take time off work.
Unexpected vehicle repairs if your car breaks down or you’re in an accident insurance doesn’t cover.
|Elective medical procedures not covered by health insurance.|
Significant expenses, such as a wedding, vacation, or new-to-you vehicle.
Home renovations or improvements designed to add to the home’s value.
Consolidating high-interest credit cards or other debt.
Paying education expenses for yourself, your spouse, or your child.
Starting a new business venture.
Purchasing a second home or vacation home.
How long can I keep a HELOC open without using it?
As we mentioned, HELOCs have an initial draw period that may last five to 10 years. You can access your credit line and often make interest-only payments during this time. Your lender might offer the option to make principal payments as well.
What if you don’t use your credit line during the draw period?
Your lender might charge an inactivity fee along with an annual membership fee. If you close your HELOC early, you might also have to pay a cancellation fee. But can a lender close your HELOC if you don’t use it?
In general, lenders cannot close a HELOC without a reasonable justification, which can include:
- Significant decline in the equity value of your home.
- Fraud or misrepresentation (for example, providing false income information).
- Action or inaction that adversely affects the lender’s security in the home.
- Changes to your financial situation that might preclude you from repaying the money you borrow.
That list doesn’t include simple inactivity, so opening a HELOC just in case wouldn’t cause your credit line to be closed later. You may, however, still pay an inactivity fee.
What happens if I get a HELOC just in case but don’t use it?
Once the draw period on a HELOC ends, your credit line closes, and you enter the repayment period. You must make principal and interest payments toward your balance if you used part of your credit line.
If you had a zero balance, you’d have nothing to repay. Your credit line would close. If you were paying an annual fee during the draw period, it would go away.
When considering a HELOC, it’s a good idea to ask about fees before applying. Standard fees include the following:
- Origination fees
- Monthly or annual maintenance fees
- Closing costs
- Prepayment penalties
- Inactivity fees
- Account closure fees
Understanding the fees can help you get a better idea of what a HELOC might cost you, even if you never have to use it.
How long do I need to be in my home to qualify for a HELOC?
No specific waiting period is required to get a HELOC. Sometimes, you can apply for a home equity line of credit within a month or two of closing on a property.
What matters more to lenders is how much equity you have in the home. Lenders often expect you to keep 15% to 20% equity in the home, measured by your loan-to-value ratio (LTV).
LTV is your mortgage debt divided by a home’s appraised value.
The formula for calculating your LTV is as follows:
|Current mortgage balance / Current appraised value = Loan-to-value ratio|
Here’s a more detailed example: If you owe $200,000 on your mortgage and your home is worth $300,000, your current LTV is 67%.
Imagine applying for a HELOC, and your lender sets a limit of 80% LTV. Your new HELOC, combined with your mortgage, cannot exceed 80% of your home’s value.
Now you need to determine your new LTV if you add debt to your home by taking out a HELOC.
If you take out a $40,000 HELOC, you have a total of $240,000 in loans against your home. And if you divide your new loan total of $240,000 by the appraised value of $300,000, you’ll get an LTV of 80%.
How to get a HELOC
Should I get a HELOC just in case? The answer depends on your situation and needs.
Should you decide to move ahead with a HELOC, the next steps are:
- Calculate your LTV to determine whether you might be eligible for a HELOC.
- Consider how much of your equity you want to access.
- Compare HELOC rates from different lenders, including variable and fixed-rate options.
- Consider getting preapproved if you can obtain rate quotes without affecting your credit.
Once you choose a lender, you can apply, submit supporting documents, and wait for approval.
If you’re considering a home equity line of credit, check out our guide to the best HELOC rates and lenders. For more guidance on tapping into your equity, check out our article titled “Is a Home Equity Loan a Good Idea?“
Author: Rebecca Lake