The Money Meets Medicine Podcast

Pros and Cons of a HELOC

By Jimmy Turner, MD
Host of Money Meets Medicine

According to the American Psychological Association, money is the number 2 stressor in American households. So, imagine a world where there was a financial tool for homeowners that would help decrease your financial stress and increase your financial security.

Sounds too good to be true? Well, it’s closer to reality than you might think with HELOCs.

This might explain why HELOC utilization saw a staggering 50% increase from 2024 to 2024. Yes, doctors are now turning towards this financial tool more than ever. But why the sudden shift?

The answer isn’t buried in complex economic theories but rather in the simple need for smarter money management. For large expenses like college tuition or even consolidating debt, HELOCs have become an unsung hero among medical professionals.

Despite this HELOCs aren’t all unicorns and rainbows. There are potential drawbacks to using one, which highlights the importance of appropriate uses for HELOCs. Let’s talk pros and cons, appropriate uses, and how you can qualify for a HELOC.

Table of Contents:

Understanding HELOCs: Basics and Qualifications

HELOCs are a game-changer in terms of having liquid equity you can tap into should you need it. In a way, HELOCs are akin to having an ace up your sleeve, providing access to your home’s equity at a moment’s notice.

What is a HELOC?

A HELOC is a revolving line of credit that’s secured against your home’s equity. It’s kind of like a credit card, but instead of a plastic card, your house is the collateral. This is both good and bad. Unlike a credit card, utilizing a HELOC inappropriately places your home at risk should you fail to pay up (more on this later).

With a HELOC, you can borrow funds up to a certain limit, pay it back, and then borrow again as needed during the draw period. This provides a much-needed security blanket and may even allow you to reduce your emergency fund. However, not everyone qualifies for a HELOC.

Qualifying for a HELOC

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To get your hands on a HELOC, there are a few boxes you need to check off:

  • You typically need at least 15% to 20% equity built up in your home.
  • A good debt-to-income ratio is a must. Lenders want to see that you can handle the extra monthly payments.
  • A solid credit score is key – usually around 600 to 700 or higher.
  • You’ll need to prove you have a steady income to make those payments.

But if you’ve got all that covered, a HELOC could be the financial tool you’ve been looking for.

The Surge in HELOC Utilization

HELOCs have been gaining some serious popularity lately. It’s no wonder HELOCs are having a moment – they offer a unique combination of affordability and adaptability that’s hard to beat.

In fact, from 2024 to 2024, the use of HELOCs shot up by a whopping 50%. That’s a lot of people tapping into their home equity.

So why are more and more homeowners jumping on the HELOC bandwagon? Well, there are a few reasons:

  1. The allure of HELOCs frequently lies in their lower interest rates compared to other lines of credit like a credit card, presenting a compelling choice for borrowers.
  2. HELOCs offer flexibility in how you borrow and repay the funds, which is a major plus for many homeowners.
  3. As property values soar, an increasing number of individuals find themselves with augmented equity, rendering Home Equity Lines of Credit (HELOCs) accessible to a broader audience.

Pros of Using a HELOC

HELOCs can be utilized in a variety of ways. Some appropriate, others not so much. For example, a couple of the pros of a HELOC are that they can be utilized for both an emergency fund purpose, and also increasing the value of your home.

Emergency Fund Backup

Life happens. A HELOC can provide some peace of mind as a backup emergency fund. While this would not be the first emergency fund bucket I’d tap into, it is worth having a backup plan should “it” hit the fan. For example, you may tap into your emergency fund sheltered in a high-yield or money market account.

Still, it is nice knowing that there is a backup should that emergency fund become depleted in a true and catastrophic financial emergency.

A HELOC us there if you need it for unexpected expenses like medical bills (no the irony isn’t lost on me here) or job loss. But it shouldn’t be your go-to savings account.

Before diving into any major financial decisions, it’s smart to build a solid safety net. Aim to have 3-6 months of expenses saved up in a true emergency fund first. Why? Because 90 days is often the time it takes for your long-term disability insurance to kick in should you become disabled. (If you don’t have disability insurance, stop now. Do not collect $200. Go and secure your most important asset – your income – through disability insurance)

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Adopting this 3-6 month emergency fund strategy not only grants you serenity but also offers a buffer to steer through unforeseen events without knocking your long-term financial aspirations off track.

Enhancing Your Property Value

Using a HELOC for home improvements can be a smart move. You’re basically investing that money back into your house. While this move is typically more advantageous in a lower interest rate environment, it is still a common use for HELOCs worth mentioning here.

Upgrades like a new roof, updated kitchen, or finished basement can boost your home’s value and make it more marketable if you decide to sell. Additionally, you have the benefit of experiencing those enhancements firsthand during your residency. Win-win.

Just be sure to choose projects with a good return on investment. A minor kitchen remodel or new garage door are usually safe bets. A swimming pool or fancy landscaping? Not so much.

Cons and Risks Associated with HELOCs

HELOCs sound great, but as was mentioned above, they’re not all sunshine and rainbows. There are some serious risks to consider before diving in.

The biggest one? Overleveraging. It’s easy to get carried away when you have all that extra cash at your fingertips. But if you’re not careful, you could end up borrowing more than you can handle.

Risk of Overleveraging

Your home is on the line with a HELOC. If you can’t make the payments, you could lose it. It’s that simple. This is why you shouldn’t use HELOCs for inappropriate reasons discussed below.

HELOCs typically have variable rates, which means your payments can go up over time. If interest rates rise or your financial situation changes, those once-manageable payments can quickly become a burden. For perspective, here are the historical prime interest rates over time:

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Moreover, the allure of tapping into a HELOC for non-essentials such as extravagant trips or a brand-new vehicle can often prove too enticing to resist. But just because you can doesn’t mean you should. Racking up unnecessary debt is a recipe for financial stress.

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Navigating the act of borrowing with a clear repayment strategy in mind is crucial to avoid drowning in debt. Don’t bite off more than you can chew, or you could end up in a world of hurt.

Inappropriate Uses of a HELOC

Not all HELOC uses are created equal. Some can boost your financial health, while others can tank it. Before you jump into bed with a HELOC, here are some ways you might consider using a HELOC that would could potentially backfire, and place your home at risk.

Leveraging Your HELOC for Alternative Investments

There are people out there who taut the benefits of real estate investing so heavily, that they would have you tap into any resources you possibly can to invest in real estate opportunities. Even to the extent of tapping into your 401K or a HELOC to put that downpayment on your investment property.

The inherent conflict of interest here is that the people teaching you this are often incentivized to tell you to buy, even when it is inappropriate. Why? Because they get paid.

Real estate isn’t the only bad idea, though. I’m looking at you cryptocurrency, starting a business, angel investing. Think long and hard before choosing this route. It is not recommended to leverage a HELOC with a variable rate and place your home at risk for alternative investments that may not pan out in the future.

Paying for Savings Goals

Another common inappropriate use of a HELOC includes items for which you can save (or borrow) to afford your kid’s college education or for other items you could put some elbow grease into so that you could afford it.

Why? Because it doesn’t make sense to put your home at risk at higher interest rates that you could probably get while borrowing for student loans. Think about it. Wouldn’t your kid rather pay off college loans than find out mom and dad lost the house because of a financial mistake that was made (with good intentions)?

Similarly, using a HELOC to pay for a car, a wedding, or a vacation is also ill-advised. Instead, work out those financial muscles and save for it.

Key Takeaway: 

HELOCs offer cash but come with risks like overleveraging and the temptation to spend on non-essentials. Smart uses include home improvements that increase value, not luxury splurges.

Conclusion

Hopefully, after reading this, HELOCs won’t be just another financial buzzword floating around in the doctor’s lounge. They’re a solid strategy for managing your finances, particularly as a backup emergency fund or improving your home during low-interest rate environments. Remember though, with great power comes great responsibility.

This journey through the world of Home Equity Lines of Credit has shown us their flexibility and potential benefits. But let’s not forget those risks! It’s all about smart management and knowing when to tap into that equity without putting your financial health on the line.

P.S. Want to learn more about personal finance? Click here to download a free copy of the best-selling Physician Philosopher’s Guide to Personal Finance!

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