HELOC Explained (and When NOT to Touch Your Equity)

How a home equity line of credit actually works, and the moments where we would not touch our equity.

You do not have to sell your home to use the equity in it. A home equity line of credit lets you pull that equity out, put it to work in a build, and pay it back without ever listing the house. Used correctly it is the cheapest money in the deal. Used incorrectly it behaves exactly like credit card debt.

What a HELOC actually is

The bank looks at your home’s value and your current mortgage, and lends against the gap in the form of a line of credit, closer to a checkbook than a loan. A credit card charges 20% to 30%. A HELOC is typically one or two points above the current mortgage rate, so about 8% when mortgages are at 6%, and you only pay when you actually draw on it.

How the amount is calculated

Take a home worth $800,000 with a $500,000 mortgage, so $300,000 of equity. The bank will not lend all $300,000, because that would put your total debt at the full value of the house. They cap total debt, mortgage plus line combined, at 80% to 90% of value. At 90% that is $720,000, minus the $500,000 mortgage, so a $220,000 line of credit. The 10% they hold back is their safety cushion.

The math on a draw

Draw $100,000 to buy a lot and at 8% you are paying $8,000 a year, roughly $665 a month. Set that against what $100,000 of down payment does on a build, which within 12 months should return 50% to 150% on the money down. You are paying $8,000 in interest to work $100,000 that is targeting $50,000 to $150,000 of return.

What not to do with it

A HELOC is interest only. There is no principal in the payment, so whatever you borrow you keep paying on until you actually pay the balance down. That makes it wrong for two things: long term holds, and toys. Buy a rental you plan to keep 30 years, or a depreciating liability, and you have simply built yourself a very large credit card.

The right use is short term, 6 to 18 months. Borrow, pay your $8,000 of interest, pay the balance back, and the interest stops. If you do want a rental out of it, build, rent, stabilize, refinance to a 30 year mortgage, and pay the line back with the refinance.

The structure: HELOC on land, lender on construction

Here is the play. A $100,000 lot with a $400,000 build, so $500,000 of cost against roughly $700,000 of value. The construction lender wants 10% down plus about 3% closing, so about $65,000, and they will not fund until permits are approved.

1. 01

   Buy the land with the line of credit

   Draw $100,000 and buy the lot for cash. Your HELOC is cheaper money than the hard money lender's, so use it on the piece you can.

2. 02

   Get plans and permits done

   Roughly $10,000, drawn from the same line. Now you own an approved, permit-ready lot.

3. 03

   Borrow only the construction

   Ask the lender for $400,000 rather than the full $500,000, because your land is already paid for.

4. 04

   Build, sell, and pay the line back

   About $8,000 of HELOC interest and roughly $30,000 in construction loan fees and interest. On roughly $200,000 of gross profit, that nets around $125,000 with none of your own cash in the deal.

This is not theoretical. One member built a 3,500 square foot personal house and pulled a line of credit over $200,000 against it to keep going. Ruben pulled $290,000. Family members have pulled $550,000 and built a project that made about $400,000. Once you start running several at once, the growth stops being linear.

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