home equity line of credit

Dear Liz: I borrowed $35,000 from my home equity account a couple of years ago to pay for a new roof. The house is paid for; there is no mortgage. My wife thinks I should pay off the balance, which is $29,000. This would create a significant gap in our liquid assets. The current payment is affordable and convenient, so I’m content to leave things the way they are. Am I missing something?

Answer: That depends on what you mean by “home equity account.”

When you borrow against your home’s equity, you typically use either a home equity line of credit or a home equity loan. Home equity loans usually have fixed interest rates, fixed payments and a defined payback period, such as 10 or 20 years. Home equity lines of credit are more like credit cards: They have variable interest rates, and you can draw down and pay back what you owe more flexibly.

However, HELOCs have a bit of a built-in trap. In the initial draw period, usually the first 10 years, you often don’t have to pay down what you owe. You’re typically required to pay only interest. When this draw period ends, you must begin making principal payments on any outstanding balance, so what you owe each month can shoot up dramatically.

That’s why HELOCs are often best used for expenses that can be paid off relatively quickly. If you need a decade or more to pay back what you owe, a fixed-rate home equity loan may be a better option. Some lenders offer a fixed-rate option as part of their HELOCs, which could allow you to lock in a steady rate on some or all of your balance and pay it off with fixed payments over time.

Regardless of what type of loan you have, the interest you’re paying probably exceeds what you’re earning, after tax, on your savings. Paying off a HELOC balance would allow you to tap that credit again in an emergency, if necessary. Paying off a fixed-rate loan wouldn’t free up credit immediately, but you could redirect the monthly payments into your savings to rebuild your cushion. If that makes you nervous, you could consider making larger monthly payments to pay back the loan sooner while keeping the bulk of your savings intact.