Why Should I Care About a Home Equity Line of Credit

As a disclaimer, please understand I am not a professional banker or financier. The information I provide here is based on how I understand things in my head, and I may not understand everything correctly.

Let's try and break down what exactly is a Home Equity Line Of Credit (HELOC). For me, the easiest part of a HELOC to understand is the H, which stands for Home. You have to have purchased a Home in order to establish a HELOC. The collateral for a HELOC is your home.

Moving forward, the E, stands for equity. I understand equity to be the amount of value within the home on which I am not paying a mortgage. As an example, if I purchased a $100K home, paid 20% towards a down payment, I now have $20K of equity within the home. As you continue to pay down the principal amount via the mortgage, your equity amount within the house will increase. Equity can also be increased as your home value increases. As a very simplistic example, say you purchase a $100K home with no money down, you have it appraised with a value of $150K, you now have $50K of equity within your home.

What makes equity so powerful is that it can be used to establish the amount you receive for a Line Of Credit, which brings us to the LOC portion of the HELOC. You can look at a Line Of Credit, as a credit card with a set limit. You can use that LOC to purchase anything you want and for the use of that money the bank charges you an interest rate, just like a credit card.

You're probably thinking, if it's just like a credit card, why waste my time accruing equity and going through the process of establishing a Home Equity Line Of Credit (HELOC). What differentiates a HELOC from a credit card is the tax savings associated with the interest payments. The interest paid on a credit card is not tax deductible whereas the interest paid on a HELOC is tax deductible, just like the interest paid on a home mortgage is tax deductible.

Interest paid on funds used from a HELOC that go towards home improvements and repairs are all tax deductible. For items purchased through a HELOC that are non-home related such as purchasing a car, there are limits on the interest which is tax deductible. For non-home related items, interest on up to $100K of a HELOC is tax deductible, $50K if you are married filing separately. I would rather pay interest on a HELOC, when purchasing a car since I would essentially not be paying any interest on the financing of the car, after I take the tax deductions.

When you are able to finance the purchase of items with no interest, after taking the tax deductions, you essentially become your own bank. We have used our HELOC to pay for large ticket items such as school tuition and to help purchase our cars.  In both cases, the interest paid on the money spent through the HELOC was tax deductible. 

A future use of our HELOC will go towards placing down payments on real estate property and possibly buying property out right, as a cash deal. Both of these paths would require us to increase the amount of our present HELOC. The topic of increasing the amount of our HELOC will be covered in my next post.

Hope to see you there.