5 Strategies for Using a HELOC to Build Wealth
Since 2020, home values have experienced significant appreciation, driven by increased demand as buyers sought more space in the wake of the pandemic, not to mention the historically low mortgage rates many already locked in. According to various market analyses, the average home price has surged by at least 20% across most regions.
This appreciation creates a unique opportunity to use available home equity to build wealth by using loan products such as a home equity line of credit (HELOC). Although it may seem counterintuitive to “go into debt” to build wealth, it can often be mathematically proven to fast-track one’s path to financial freedom.
This strategy is borrowed from the Velocity Banking method, which has helped homeowners around the world use HELOCs to pay off their mortgages faster and consolidate of high interest debt for the last three decades. Needless to say, these same cash flow efficiencies can be applied to acquiring assets that appreciate, create steady cash flow, or both.
What Exactly is Home Equity?
Quite simply, home equity is the difference between the value of what you own vs. what you owe on your home. It’s the value of your home minus any outstanding loans against it.
The simplest way to calculate home equity is to imagine how much cash you would deposit in your bank account if you sold your house today after paying off any closing costs and loans against it.
So if you could sell your house for $700,000 and you have $500,000 in total loans collateralized by the property, then your home equity is $200,000.
The problem with home equity is that it’s a phantom number that floats up and down but doesn’t have any real utility in your life until you either sell your house or do a cash-out refinance…
or unless you utilize your home’s equity with a HELOC strategy to acquire cash-flowing investments that not only eliminate the debt but also build a portfolio of appreciating assets.
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Unlocking Trapped Liquidity using a Home Equity Loan or HELOC
Many families with significant home equity don’t want to sell because they either like where they live, they locked in a low-interest mortgage, or both.
If this is the case, opting for a home equity loan (HELOAN) or a home equity line of credit (HELOC) provides a viable solution. These loans allow homeowners to convert the illiquid equity in their primary home into cash they can use without sacrificing their primary residence or increasing the rate on their remaining mortgage balance.
What is the Difference Between a HELOC and Home Equity Loan?
Both loan products allow homeowners to access cash by borrowing against their home equity without affecting their existing mortgage. However, the major difference between a home equity line of credit and the lesser-known home equity loan can be summed up in one word: FLEXIBILITY.
How does a Home Equity Loan (HELOAN) Work?
Home equity loans are less flexible because they involve a one-time lump sum cash out. Home equity loans work like a cash-out refinance in that both the fixed interest rate and fixed monthly payments are locked and amortized for the life of the loan. However, unlike cash-out refinances, home equity loans do not affect your existing mortgage loan since it only accesses the home equity of your outstanding mortgage balance.
How does a Home Equity Line of Credit (HELOC) Work?
A HELOC, on the other hand, is much more flexible in many ways than a home equity loan. For that reason, it is often much more appealing to those wanting to build wealth. First off, you don’t need to borrow against all of your available home equity right away, although some HELOC lenders require a minimum initial draw. Since the remaining balance will fluctuate, your minimum monthly payment due will usually be interest-only. Lastly, HELOCs often have a variable interest rate, but many offerings come with fixed interest rates for some promotional period.
However, the major advantage of a home equity line of credit is that it charges simple interest vs. home equity loans which have front-loaded amortized interest like traditional mortgages. A HELOC operates similarly to credit card debt in that interest charges only accrue as simple interest on the average daily balance.
Thus, homeowners can withdraw funds at will with a HELOC up to their available equity, established by the lender. During the draw period, typically lasting 5 to 10 years, borrowers can access their funds as needed and are only required to make minimum monthly payments calculated as simple interest on the HELOC balance.
After this draw period ends (usually after 3-10 years), the repayment period begins, and the remaining balance is amortized into principal and interest payments over a set loan term like 20-30 years. The terms of a HELOC offer significant flexibility in managing cash flow prior to the repayment period ideal for building wealth, although you must employ careful cash flow planning to pay back the borrowed money against your home’s equity.
5 Ways to Use a HELOC to Build Wealth and Increase Cash Flow
Leveraging a Home Equity Line of Credit (HELOC) to amass assets can certainly speed up one’s journey to financial freedom if deployed and managed properly. However, it is essential to carefully plot out both your cash flow and risk management strategies to safely navigate the complexities associated with using borrowed capital.
Remember that leverage can work two ways. As the name suggests, a lever can help you better lift heavy objects, but it can also snap if you try and take on too much.
1) Using a HELOC to Invest in Real Estate
Down Payments on New Investment Properties
Utilizing a Home Equity Line of Credit (HELOC) for a down payment on an investment property can be invaluable for those looking to expand their rental property portfolio. By leveraging their home’s equity, investors can access the necessary capital to acquire more rental property without having to liquidate other investments, deplete their savings, or sell their primary home.
In fact, sometimes, you can get the best deal by making an all-cash offer to beat out other buyers, even if you refinance the new investment property after the purchase.
Proper cash flow analysis is necessary to ensure that the income generated from the new investment property will cover both its mortgage payments plus the variable interest costs associated with the HELOC. Quite frankly, there should also be surplus cash flow to aggressively repay the HELOC for the investment choice to pencil.
That way, you can more quickly restore the borrowing capacity of the HELOC to seize future opportunities that arise in the real estate market or to handle major improvements will eventually be needed.
Improvements to Increase Real Estate Value or Rents
Using a HELOC to invest to substantially improve existing investment properties can yield significant increases in both property value and rental income. Upgrades such as modernizing kitchens and bathrooms, enhancing curb appeal, and incorporating energy-efficient appliances can not only attract higher-paying tenants but also improve your property’s marketability and longevity.
Utilizing a Home Equity Line of Credit (HELOC) in conjunction with the BRRRR (Buy, Rehab, Rent, Refinance, Repeat) method can significantly amplify an investor’s ability to acquire and improve distressed rental properties, swiftly turning them into cash-flowing assets. This approach can rapidly kick-start one’s rental property portfolio getting the most bang for your buck in both appreciation and cash flow per dollar invested.
2) Using a HELOC to Invest in Your Own Business
Seed Capital for Starting a New Business Venture
Utilizing a HELOC as seed capital can provide entrepreneurs with the necessary funds to get proof of concept with a minimum viable product offering without diluting their business equity by raising capital at low immature valuations. This approach allows for flexibility in financing, enabling business owners to allocate loan proceeds towards initial costs such as research and development, inventory, marketing, and operational expenses.
However, entrepreneurs must have a robust business plan in place that mitigates risk and forecasts sufficient cash flow to ensure timely repayment of the HELOC. Borrowers should have a clear path to monetization, which may lead to having the business itself qualify for its own line of credit to practice Velocity Banking within a corporation or LLC. This would free up the business owner’s HELOC, so they have enough equity available in the future to expand their business beyond what the bank may be comfortable lending the business itself.
Acquiring New Business Equipment or Inventory
Often, an entrepreneur’s biggest asset is his/her business, and the second-biggest asset being their primary home. Therefore, converting this trapped home equity into liquid capital via HELOC can help an entrepreneur acquire new business equipment or inventory, thereby optimizing the performance of their best-performing asset.
Using a HELOC to build wealth through their business will almost always be a better option than expensive inventory financing options like factoring (borrowing against future receivables at around 30% APR). However, even if financing business equipment or vehicles directly comes at a slightly higher rate than using their HELOC, business owners may want to preserve the home equity available to borrow through their HELOC strategy for future opportunities or emergencies.
Investing in Education and Personal Growth
Keep in mind that despite how successful your business is, you will likely always be your family’s biggest asset. So, investing in education that can help you monetize new skills may prove to be a valuable way for using a HELOC to build wealth.
Separately, I’ve personally found that quality personal growth seminars and coaching has often yielded at least one or two valuable business ideas and/or money making/saving behaviors to implement. Not to mention that much of what I have learned at these events has helped my mindset in such a way that the increased monetary success has led also led to enhanced enjoyment and fulfillment.
3) Using a HELOC for Private Money Lending
Private Loans and/or Deed of Trust Lending
Engaging in private-money lending or deed of trust lending through a HELOC can offer lucrative returns while diversifying an investment portfolio. By acting as a private lender, homeowners can capitalize on their home equity, earning interest on funds loaned to real estate investors or other borrowers.
In fact, when investing in these short-term amortized notes, you are benefiting from the very thing Velocity Bankers are striving to avoid…front-loaded amortized interest. Since you are being repaid principal and interest on a set schedule, you can theoretically start ramping up your investment in these notes, which not only exponentially stacks your cash flow but also systematically pays down the money borrowed from the HELOC.
However, prudent investors must conduct thorough due diligence on potential borrowers and assess the collateralization of loans to mitigate risks associated with private lending if the borrowers stop making monthly payments.
Assuming you research the note issuers thoroughly, contractual cash flow payments will pour in, which can exponentially increase the efforts of using your HELOC to build wealth and pay down your mortgage faster.
4) Using a HELOC Investing in Stocks
Using your home equity line of credit to randomly invest in stocks can be a recipe for disaster. If things go badly in the short run, you could potentially lose money in the underlying stocks as well as going deeper into HELOC debt to finance them.
However, when you zoom out and look at the rolling returns of the S&P 500, you can see that given enough time, dollar cost averaging into a well-diversified portfolio eventually proved to be positive even during the worst historical periods. What you see below is the range of returns from both the best and worst outcomes during different historical timeframes.
When considering the last 70 years of the S&P 500, if you look through simply a 1-year lens, the S&P 500 may have made you as much as 52% but lost up to 37%. However, as you stretch out the time frame, you find that the range of returns narrows. For instance, the worst 5-year period within the last 70 years only lost 2%, and the worst 20-year period produced a positive 6% year-over-year average return.
Regardless, I am not saying you should use your HELOC to build wealth with stocks solely because of their appreciation potential. Using your home’s equity to build wealth with stocks requires additional cash flow to service the HELOC payments. Even the highest-paying dividend stocks in the S&P 500 won’t provide sufficient cash flow to service an ongoing home equity loan.
However, one ingenious way to create enough free cash flow to pay HELOC interest and repay additional principal is to employ the wheel strategy.
Cash Flow Potential of the Wheel Strategy
Generally, the wheel strategy can conservatively generate 1%-2% percent of free cash flow per month, regardless of the stock’s movement. One of my clients who is also a real estate investor looks at the wheel strategy like he does his investment properties. That means he focuses more on the consistent cash flow generated rather than the price fluctuation of the underlying asset itself, which as you’ve seen above should appreciate over time.
How the Wheel Strategy Works
Doing the wheel strategy in a margin account first utilizes the equity of your other stock/ETF holdings as a placeholder to buy the stock, instead of borrowing the cash right away on margin or from your HELOC. So, no interest is charged when you generate option income during the first leg of the wheel strategy.
You would only borrow against your home equity if you were assigned the stock on margin to remove the risk of getting a margin call, which substantially reduces the risk of the entire strategy. At that point, you would sell a covered call on the stock at or above the price you were assigned.
Now you have generated option income twice of the same stock, and you perhaps can still benefit from appreciation. If the stock goes down, the income generated offsets some of the risk and you can continue to sell options on your position to generate cash flow.
Thankfully, your maximum risk will be buying stocks you want to own anyway at a price lower than they’re trading today. So you are essentially getting paid to DCA (dollar-cost-average) into quality businesses of your choosing.
Risk Disclaimer of the Wheel strategy: Keep in mind that markets tend to rise slowly and then crash suddenly. Said another way, stocks tend to take the stairs on their up and the window on their way down.
So you may go months generating free cash flow without ever buying one stock, and then suddenly have several assigned to you at once, even if you’re diversified. At that point, you would utilize the HELOC to immediately repay any margin loans, and use cash flow from the covered calls to pay interest and reduce principal on your loan.
When navigated correctly, this strategy not only helps manage the costs associated with borrowing through a HELOC but also allows investors to benefit from capital appreciation and consistent cash flow generation to fund other investment opportunities, business ventures, or lifestyle choices.
5) Building an Emergency Fund
To be clear, using a HELOC to build an emergency fund will not have a positive net return right away. In fact, at the time of this writing, high-yield savings accounts are yielding around 5%, whereas promotional offers on HELOCs are around 7%.
However, establishing a financial safety net is a critical financial strategy, especially for those leveraging a Home Equity Line of Credit (HELOC) to build wealth. While a HELOC offers a flexible method to access funds for investment or other purposes, it can also help with financial strain if sudden expenses arise or investment returns do not meet expectations.
Keep in mind that using a HELOC for an emergency fund is not reliable, since lenders have a history of revoking access during recessionary periods. For that reason, it is often advisable to utilize a high-yield savings account for their 3-6 month emergency fund.
The ultimate financial safety net is using Whole Life as your bank, emergency fund, and opportunity fund. Not only is Whole Life principal protected, but it has guaranteed growth every year as well as annual dividend payments, all of which accrue tax-free. If the insured passes away prematurely, the death benefit over and above the cash value may be enough to pay off the entire HELOC balance as well as the primary balance.
The practice of Infinite Banking with Whole Life insurance has much in common with Velocity Banking. In fact, each can be enhanced when both are deployed together.
4 Risks of Using a HELOC to Build Wealth
While a Home Equity Line of Credit (HELOC) can offer significant benefits, it also carries inherent risks that must be meticulously evaluated. The volatility of a HELOC’s variable interest rates can lead to unexpected fluctuations in repayment amounts vs. a fixed mortgage rate. This unexpected strain can cause borrowers to deviate from the plan and become further in debt or at worst cause foreclosure on their house.
Additionally, the reliance on a HELOC can create a precarious financial situation if property values decline, as this may jeopardize the access to enough equity that homeowners depend upon. Therefore, a thorough understanding of these risks below, combined with robust financial planning, is crucial to effectively utilize a HELOC without falling into financial trouble.
1) Over-leveraging a HELOC (without a backup plan)
The benefits of using a HELOC to consolidate debt or build wealth may excite someone so much that they become complacent, ignoring the risks associated with over-extension.
While leveraging home equity can accelerate wealth-building strategies, the potential for over-leveraging poses significant risks. Homeowners who over-leverage and exhaust all of their equity may find themselves painted into a corner with insufficient reserves or cash flow to maintain the leverage.
No matter how good an opportunity looks on paper, the risk that may appear to be unlikely will sometimes come to fruition, or the investment itself may take longer than expected to blossom. Only those with staying power get to realize an investment’s full potential over time.
When using a HELOC to build wealth or pay off your mortgage faster, you should have multiple sources to access cash on demand. Learn how to position different assets you already own to become your own banker and create the ultimate emergency fund matrix.
2) Losing Your Primary Income Source or Having Unexpected Expenses
One of the most significant risks associated with leveraging a Home Equity Line of Credit (HELOC) arises from potential disruptions to one’s primary income source. The loss of a job, a reduction in hours, or unforeseen circumstances such as medical emergencies can create substantial financial strain, making it challenging to maintain timely payments. This strain can jeopardize not only the ability to service the HELOC debt, but also the risk of losing the home altogether if their minimum payments fall behind.
Additionally, unexpected expenses, such as repairs or sudden financial obligations, can compound the pressure on a homeowner’s budget. While a HELOC may provide immediate access to funds, it is essential to acknowledge that these borrowed sums will need to be repaid, often at variable interest rates.
In the event of financial setbacks, the combination of diminished income and increased debt obligations may lead to a stressful financial situation. Consequently, prudent financial management and the establishment of a robust emergency fund are critical steps to mitigate these risks while navigating the complexities of using a HELOC as a wealth-building tool.
3) Variable Interest Rate Fluctuations
When utilizing a Home Equity Line of Credit (HELOC), one of the most pressing concerns revolves around the volatility of interest rates. Unlike a fixed mortgage rate, HELOCs typically come with a variable rate that can fluctuate over time based on market conditions. Such variability can pose a significant threat to financial stability, as payment amounts can significantly increase, leading to heightened monthly expenses that may not have been accounted for in initial budgetary plans. Homeowners may find themselves facing higher repayment obligations, which can erode cash flow, strain budgets, and ultimately impact their ability to adhere to their original wealth-building strategies or debt management plan.
To effectively manage the risks associated with interest rate fluctuations, it is imperative for borrowers to conduct robust financial planning that includes interest rate projections and scenarios. This entails regular monitoring of market trends and a proactive approach to debt management, ensuring that there is sufficient financial cushioning to accommodate potential interest hikes. Establishing a fixed-rate conversion option on the HELOC may also be beneficial, allowing homeowners to lock in a stable rate when market dynamics become unfavorable. Such measures not only mitigate the risks of rising rates but also support the overall strategy of using a HELOC as a tool for wealth accumulation.
4) Market Fluctuations and Home Value Depreciation
The real estate market is subject to cyclical fluctuations that can unexpectedly lead to declines in property values. Should the market shift unfavorably, homeowners may find themselves in negative equity positions, where the outstanding balance on their HELOC exceeds the current value of their primary home.
If so, most lenders may either cap or call your home equity line of credit. Capping means you may not be able to borrow any additional funds, even if your balance was under the maximum draw amount. I had this happen to me in 2009 after property values plummeted, even though I was current on my payments and nowhere near my max draw amount.
Keep in mind that these abrupt drops in home values usually correlate to stock market losses, which may compromise your other backup sources to access cash on demand. That is why it is so important to have multiple non-correlated sources of emergency funds.
Having your lender calling your HELOC is the worst-case scenario, making the loan due immediately. This may force you to sell the same assets you were using the HELOC to build wealth, quite possibly at a deep discount depending on market conditions. Check your loan contract language to make sure this call feature isn’t available to the lender before setting up a HELOC.
Final Thoughts on Using a HELOC to Build Wealth
Leveraging a Home Equity Line of Credit (HELOC) can serve as a potent wealth-building tool, allowing homeowners to tap into their property’s equity for investment opportunities, property upgrades, or paying down high-interest debt. The flexibility of a HELOC can enable borrowers to access funds as needed, empowering them to seize investment opportunities quickly and efficiently, while potentially enjoying tax benefits associated with interest payments.
However, the risks associated with a HELOC must not be overlooked. As outlined, the threats of variable interest rate fluctuations, market depreciation, and unexpected financial setbacks can present significant challenges, jeopardizing a homeowner’s financial stability and overall investment strategy. Such risks emphasize the critical importance of prudent financial planning and management when utilizing this financial instrument.
Before implementing a HELOC strategy, it is advisable for homeowners to seek custom advice from financial professionals. An experienced adviser can provide tailored insights, helping to navigate the complexities of borrowing against home equity while addressing individual circumstances and long-term financial goals.
John “Hutch” Hutchinson, ChFC®, CLU®, AEP®, EA
Founder of BankingTruths.com
John “Hutch” Hutchinson has no affiliation or association with any of the following and does not feel compelled to do so since he is a published life insurance authority, policy design geek, and a multi-faceted accredited financial strategist:
- The Infinite Banking Concept®, The Infinite Banking Institute, Nelson Nash, nor his book Becoming Your Own Banker – Unlocking the Infinite Banking Concept
- Bank on Yourself, Pamela Yellen, nor her book The Bank on Yourself Revolution
* “The Infinite Banking Concept®” is a registered trademark of Infinite Banking Concepts Inc.
** “Bank On Yourself®” is a registered trademark of Hayward-Yellen 100 Limited Partnership.
