The Pros and Cons of a Home Equity Line of Credit (HELOC)

Photo to accompany story about the pros and cons of a HELOC. Adobe Stock
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Just like a credit card, a home equity line of credit (HELOC) is a revolving line of credit you can use to pay for home repairs or other expenses.

Unlike a credit card, you could lose your house if you can’t pay it off. 

That’s because HELOCs are secured lines of credit, using your home equity (aka your house) as collateral.

While most people know the basics of how a credit card works, you’ll be forgiven if you have no idea where to start with a HELOC. And while they’re commonly mixed up with home equity loans, a HELOC works differently. 

If you’re thinking about tapping into your home’s equity with a home equity line of credit, make sure you weigh the benefits against the potential downsides that come with this method of home equity financing. 

What is a Home Equity Line of Credit (HELOC)?

A home equity line of credit (HELOC) is a line of credit secured by your home that you can use for anything. A HELOC is similar to a credit card, in that you can spend up to your credit line maximum. You’ll only have to pay off what you spend, unlike a loan that would require you to pay off the full amount of the lump sum you receive upfront. 

HELOCs traditionally work on a 30-year model, where you’ll have a 10-year draw period where you can spend with your HELOC, then you’ll have 20 years to pay off whatever you spent.

Pros and Cons of HELOCs

Pros

  • Lower interest rates than credit cards and other loans

  • Option to fix your interest rate

  • Only pay for what you spend

  • There are no regulations about what the money can be used for, but you can get a tax benefit for certain purchases

  • There are often discounted rate offers for an introductory period

  • Higher credit limit than credit cards, depending on your equity

Cons

  • HELOCs can come with a minimum withdrawal amount

  • There can be limitations to how you access the funds

  • There is a set withdraw period after which you cannot access any further funds

  • There can be fees associated with a HELOC

  • You can hurt your credit if you do not make payments on time

  • Harder to qualify right now

Pros

Lower interest rates

HELOCs will have a lower interest rate than credit cards. The average interest rate for a HELOC is below 5% right now, while credit cards have an average APR of 16%

They have variable-rate interest, meaning that the rate will fluctuate over time, but even when rates rise they are lower than most credit cards. 

Option to fix your rate

Some lenders offer the option to fix your interest rate on your outstanding balance so you’re “not exposed to rising interest rates after you’ve piled up a balance,” says Greg McBride, chief financial analyst at Bankrate.

Since rates are low right now and unlikely to rise significantly for awhile, this isn’t something to be worried about at the moment, says McBride.

Pro Tip

Check your local credit unions for HELOCs, which can often offer more competitive rates.

Only pay for what you spend

Like a credit card, you’ll only have to pay for what you spend on the home equity line, plus interest. This is different than other home equity financing options, like home equity loans, where you would have to take out and pay back the entire loan amount regardless of whether or not you used it.

Use the money for anything

Just like a credit card or a personal loan, you can use the funds from your HELOC for whatever you want. But if you use it for a home project you can get a tax benefit. 

You can deduct any interest paid on a home equity loan or a HELOC if it is used to buy, build, or improve the taxpayer’s home that secures the loan.

Some HELOCs come with intro offers

Intro offers for HELOCs are a nice perk, but shouldn’t necessarily sway you toward one lender or another since these are longer-term loans. A 6-month interest rate discount won’t make that much of a difference if you continue using your HELOC over the average 10-year draw period. 

Your credit limit will be higher than on most credit cards

Because you’re securing your HELOC with what is likely your biggest asset, your home, your credit limit will probably be much larger than on a standard credit card. Your exact limit will be dependent on how much equity you have in your home, your existing credit history, and other factors.

Cons

Minimum withdrawal amount

This option is not for you if you’re looking for a new way to spend day-to-day. Most HELOCs require a minimum withdrawal of around $10,000, sometimes more.

There may be some hoops to jump through to use the funds

Make sure you check how you can access your HELOC. Some can only be accessed via checks, while others use cards or online banking. 

There is a set draw period

You will only be able to access your HELOC for a set amount of time. Most HELOCs use a 30-year model, where you have a 10-year draw period and a 20-year repayment period. After your draw period ends you won’t be able to access your HELOC anymore.

Fees 

HELOCs can be fee-heavy. Annual fees, application fees, appraisal fees, attorney fees, and transaction fees can add up. Not every HELOC account will charge all of these fees, but make sure you know what fees could apply to you. 

They can hurt your credit if you don’t use them responsibly

Like any loan, if you don’t make your HELOC payments on time it will damage your credit. It’s also important to remember that a HELOC is secured by your home, which means if you default on your payments the lender can seize your house. 

Harder to qualify right now

Lenders have gotten more strict with their qualifications for HELOCs and home equity loans due to the recession caused by the pandemic. You’re going to need better credit and more equity in your home to qualify for a HELOC today, but there are other options out there. 

Alternatives to a Home Equity Line of Credit

A HELOC is a good way to put your home’s equity to work for you, but it’s not the only way. If you don’t qualify for a HELOC, you’ll probably have similar difficulties getting a home equity loan, so check out two other options:

Cash-out Mortgage Refinance

A cash-out mortgage refinance involves taking out a home loan that’s larger than what you owe on a current mortgage and getting the difference in cash.

The requirements for qualifying for a refinance right now have tightened a bit, but not as much as for HELOCs and home equity loans.

Home Equity loan

A home equity loan works like a traditional loan that’s secured by your house. You’ll get a lump sum payment upfront that you can use for whatever you want, and then you’ll have set monthly payments until you pay back what you owe.

Personal Loans

A personal loan will get you a lump-sum of cash upfront, though rates vary. Like a HELOC, you can use the funds in any way you want. 

You’ll also need to have good credit history for approval, and it may be more difficult to find lenders at the moment as the credit market tightens. 

Bottom Line

A HELOC can help fund larger projects like home renovations or paying for a child’s college tuition. But they’re not without risk, and if you default you could seriously damage your credit and even lose your home.