Pros And Cons Of A Home Equity Line Of Credit (HELOC)

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Key takeaways

  • A HELOC allows you to access your home’s equity over a period of time — you can borrow exactly what you need as you need it, typically for lower rates than other forms of credit.
  • However, HELOCs have variable interest rates, which means you might pay more in interest as rates fluctuate, and your home is the collateral, so if you don’t repay what you borrow, you could lose your home.

Unlike home equity loans with a fixed amount, home equity lines of credit, or HELOCs, allow you to borrow from your home’s equity as needed over a set time frame. This can help you keep your monthly payments down and avoid unnecessary debt and interest. However, HELOCs also have a variable rate, and the sense of a seemingly limitless credit line could make them risky for less-disciplined borrowers.

Overview: What are the pros and cons of a HELOC?

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Pros

  • Lower interest rates
  • Flexibility
  • Possible tax-deductible interest
  • Potential boost to credit
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Cons

  • Variable rates
  • House on the line
  • Smaller equity cushion
  • Potential to run up balance quickly

Pros of a home equity line of credit

Lower interest rates

While home-loan interest rates overall have risen dramatically since 2022, HELOC rates still tend to be lower than those on credit cards and personal loans. If you qualify for the best rates, a HELOC can be a less expensive way to consolidate debt or finance a home renovation.

Flexibility

With a HELOC, you use the funds as you need them, then repay only what you borrowed (with interest). In contrast, home equity loans and personal loans offer a lump sum that has to be repaid in full (also with interest), whether you use all of the money or not. If you wind up needing less cash than you thought, you’ll have smaller repayments, too. Most home equity lenders also offer flexibility in terms of how you access your HELOC funds, such as debit cards, checks, ATMs and online transfer. In addition, some allow you to convert all or a portion of your HELOC balance to a fixed rate, so you won’t risk getting hit with higher interest later on. Another point of flexibility: repayment. Many lenders offer the option of an interest-only HELOC, with which you only pay interest during the draw period (typically 10 years). This helps keep your payments manageable.

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Possible tax-deductible interest

Even after the Tax Cuts and Jobs Act of 2017, you can still deduct interest paid on a HELOC if you use the money for home renovations. Specifically, the IRS allows deductions on HELOC or home equity loan interest payments if the funds are used to “buy, build or substantially improve the residence.” You can only take the deduction up to a certain threshold, however, based on your total mortgage debt. You must also itemize deductions to take advantage of this writeoff.

Potential boost to credit

Two of the most important components of your credit score are your payment history and credit mix. Adding a HELOC to your history and paying it on time can help boost your score. (However, keep in mind that changing your credit utilization by taking on the HELOC could actually make your score go down, too.)

Cons of a home equity line of credit

Rates are variable

While home equity loans come with a fixed interest rate, HELOCs have variable rates. This means that your rate can go up or down based on economic conditions, monetary policy and other factors. Even if you take out a HELOC at a lower rate, you could face much higher interest rates when it comes time to repay.

House is on the line

A HELOC is a secured loan, meaning you put your home up as collateral. While secured loans tend to have lower rates, you’re taking on some additional risk by putting your house on the line. “Because you are borrowing against your home, if you can’t make your monthly payments, you risk foreclosure,” says Sean Murphy, assistant vice president of mortgage operations, closing at Navy Federal Credit Union.

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Smaller equity cushion

When you borrow through a HELOC, you’re borrowing against your home’s equity. If home prices drop, you could wind up owing more than your home is worth. In addition, if your home is your largest asset, tying up your equity with a HELOC might limit additional opportunities to borrow, as well as the ability to leverage your equity in an emergency.

Potential to run up balance quickly

Because many HELOCs come with interest-only payments during the draw period, it’s easy to access cash without considering the financial ramifications. “If the borrower is not returning funds to this line of credit, then the loan eventually begins to amortize and the payments go up significantly,” says Joseph Polakovic, owner and CEO of Castle West Financial in San Diego. Bottom line: If you’re not expecting or accounting for the increase in monthly payments at the end of the draw period, it can be an unwelcome surprise.

Should you get a HELOC?

HELOCs can be a good option if you have substantial equity in your home and you know you’ll need access to cash with some regularity over a period of time — college tuition bills over the course of several years, for example. If you’re looking to spend as you go, and only pay for what you’ve borrowed when you’ve borrowed it, a HELOC is probably a better option than a lump-sum home equity loan, says Murphy.

However, HELOCs can be risky. The variable interest rate could increase, and if you’re unable to pay back the loan for whatever reason, you could lose your home. In addition, you might end up with a false sense of bottomless funds during the draw period, which can make for a stark return to reality when the payback period begins.

Alternatives to a HELOC

Here are some loan alternatives to consider if a HELOC isn’t right for you:

  • Home equity loan: A home equity loan is similar to a HELOC, but instead of a credit line, it gives you a lump sum of cash. You’ll have a set repayment period and a fixed interest rate, meaning your monthly payment will never change. If you know exactly how much you need upfront, a home equity loan could be a better option than a HELOC.
  • Cash-out refinance: A cash-out refinance replaces your existing mortgage with a new loan with a higher balance at a new interest rate. Many lenders allow you to refinance and borrow up to 80 percent of your home’s value, with you receiving the difference in cash. Generally, a cash-out refi is only a good idea if you can get a lower interest rate, afford the closing costs and plan to stay in your home for a long time.
  • Personal loan: Like home equity loans, personal loans come with a fixed monthly payment, a fixed interest rate and a lump sum of money upfront. The big difference between these loans and HELOCs is that personal loans are unsecured, so you don’t have to put your home or any other asset up as collateral. The catch is that they tend to come with higher interest rates than home equity products.
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Bottom line on HELOC pros and cons

Home equity lines of credit (HELOCs) are an option for disciplined borrowers who want to take advantage of their home’s equity. HELOCs have the most flexibility in terms of what you can borrow and when you can pay it off, compared with other home equity products.

However, HELOCs also come with risks. You must put your home up as collateral, and interest rates are variable. When considering a HELOC, think honestly about your financial habits, the potential risks and the nature of your funding needs. HELOCs work best if you require an indefinite sum, or need funds for an extended period of time.

Frequently asked questions on HELOCs

  • A home equity line of credit (HELOC) offers a line of credit based on the equity in your home that you can borrow against when you need to. Like credit cards, HELOCs come with variable interest rates. During the draw period, typically 10 years, your monthly payment will vary depending on the current interest rate and how much you borrow at any given time. After the draw period closes, you won’t be able to borrow any more funds and you’ll begin repaying the line plus interest over a repayment period, often up to 20 years.

    Learn more: What is a HELOC (home equity line of credit)?

  • A HELOC has two distinct stages: a draw period and a repayment period. The draw period is the first stage, usually lasting between five years and 10 years, when you’ll borrow funds as needed. During this time, you might only be required to pay interest. Once the draw period ends, you’ll enter the repayment phase, which can be as long as 20 years. During this time, you’ll repay what you borrowed, plus interest.



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