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

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  • A home equity line of credit, or HELOC, is one way you can turn your home equity into cash.
  • HELOCs allow you to withdraw funds over a long period of time and make interest-only payments.
  • But the line of credit is secured by your home, and interest rates and monthly payments can vary over time.

A home equity line of credit – more commonly referred to as a HELOC – is an option for homeowners looking to leverage their home’s value in cash.

Unlike other options, however, HELOCs offer a line of credit, which allows you to withdraw, repay, and then withdraw more funds as needed over an extended period of time. While this may be the right strategy for some homeowners, there are drawbacks as well.

Here are the pros and cons you should consider before taking a HELOC.

What is a HELOC?

HELOCs allow you to turn a portion of your equity into a line of credit, which works much like a credit card.

During the draw period (usually 10 to 15 years), you can withdraw and replenish funds as you see fit, making interest-only payments in most cases. Then, once you’ve entered your repayment period (typically 10 to 20 years), you’ll start making monthly principal and interest payments to your lender.

HELOC pros and cons: at a glance

HELOCs offer homeowners a wide range of benefits. But they also have some notable drawbacks. Be sure to consider these before bringing a HELOC to your home.

HELOC pro

Here are more details on the benefits of HELOCs.

1. You can withdraw funds for many years

One of the biggest advantages of a HELOC is that it allows you extended access to money. You can withdraw $ 10,000 here, another $ 30,000 there, refund them and withdraw even more. This makes a HELOC great for covering recurring expenses (like tuition, for example) or unexpected repairs, medical bills, and other charges that may arise in the future.

“This method can be used over and over again as funds are repaid,” says Esther Phillips, senior vice president and director of sales for Key Mortgage Services. “It’s a good option if the funds are only needed for a short period of time or if you’re not sure how much and when.”

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2. You only pay interest on what you borrow

Another advantage of HELOCs is that you only pay interest on the funds actually withdrawn. If your line of credit is $ 50,000, but you only use $ 20,000, you will only be charged interest on that $ 20,000, not the entire line.

This helps minimize long-term interest costs, particularly when compared to other loan options, which typically charge interest on the full loan amount from day one.

3. You can use the funds however you like

There are no restrictions on how you use HELOC funds. Many homeowners use them for repairs and renovations, while others use them for expenses completely unrelated to their home, such as taking a vacation or consolidating debt.

“The main advantage of a HELOC is that it has the same flexibility as a credit card,” says Deb Gontko Klein, Chandler, Arizona, branch manager of Reliability in Lending at Primary Residential Mortgage Inc. “You are only making payments on what is been used and can repay and reuse it as needed for home improvements, remodeling, landscaping, your child’s college or even paying higher interest credit cards. “

4. High loan limits

Depending on how much equity you have in your home, HELOCs can potentially offer you access to very large sums of money. Some lenders actually offer up to $ 500,000 in financing, far more than most other financial products can provide.

As Adam Boyd, head of equity lending at Citizens Bank explains, “HELOCs generally offer higher loan amounts and lower interest rates than unsecured loans, lines of credit and credit cards.” How much you ultimately qualify will depend on how much equity you have and your credit score.

5. Payments start at the bottom

Most HELOCs only require interest payments during the draw period, which can keep the monthly cost down. This can be useful if you are on a tight budget or need to preserve cash flow. Please note that your payments will increase to include interest and principal once the repayment period is entered.

6. Interest may be tax deductible

In some cases, you may be able to deduct your HELOC’s annual interest costs on your federal tax return. This is only the case if you use the borrowed funds to “buy, build, or substantially improve your home,” according to the IRS, so keep that in mind if you’re aiming for a tax deduction.

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“Interest paid on a home loan or HELOC for any other purpose, such as buying a real estate investment or debt consolidation, is not tax deductible,” says Heather Harmon, head of Opendoor Finance, a broker. online mortgages.

HELOC cons

Here are more details on the downsides of HELOCs.

1. Rates are variable

HELOCs have variable interest rates, which means that the rate you are charged can change. Typically, these rates are tied to the main rate. When that rate goes up or down, so does the rate on your HELOC. This can make budgeting for payments difficult, as it can change often.

“Prepare your budget for the worst-case payments,” says Klein. “Estimate your payment amounts with rates that increase another 1% to 2% so that you are well prepared when the rates rise.”

2. Risk of payment shock later

While HELOCs allow for low, interest-only payments during the draw period, that’s not always a good thing, especially if you’re withdrawing large amounts of cash. In this case, you may be faced with a significant increase in payments once you enter the repayment period.

3. Your home is at stake

HELOCs use your home as collateral. While this can alleviate some of the risk for the lender and allow them to offer lower rates and more favorable terms, it is also risky. If you don’t make payments, the lender can foreclose on your home to pay off the debt.

“It’s important to make sure you’re prepared to manage your line of credit responsibly and have room in your budget to adjust your monthly payments,” says Harmon.

4. There may be penalties for prepayment

Some lenders charge fees if you close your HELOC too quickly after opening it. In some cases, a lender may also charge you for any covered closing costs on your behalf.

“HELOCs are best suited for homeowners who plan to stay on the property for a few years, as some lenders will charge prepayment penalties if the loan is closed in the first two to three years,” says Boyd.

5. You can pay ongoing commissions

HELOCs often have annual maintenance fees, transaction fees, and other ongoing costs that you will have to pay over the life of the loan. There may also be inactivity fees if you go too long without withdrawing funds.

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Frequent questions

A HELOC is a secured line of credit from your home. You can withdraw and redeem funds many times during the draw period, usually 10 to 15 years. Home equity loans give a homeowner an upfront payment, a lump sum, and are not replaceable; payments begin immediately thereafter. Both allow you to turn your equity into cash.

The exact requirements for a HELOC vary by lender, but you can usually expect to need a credit score in the mid-600s or higher, at least 10% to 15% equity in your home and a low debt-to-income ratio, which means that your existing loan and debt payments don’t absorb too much of your monthly income.

You can get a HELOC through many banks, credit unions, mortgage lenders, and online lenders. You will need to fill out an application, accept a credit check and submit some financial documents. The lender can also order a home appraisal to confirm the value of your property.

A HELOC is typically a second mortgage. The term “second mortgage” simply means that the lender has a secondary right to the property in the event of a loan default (primary right goes to the principal mortgage lender). If you no longer have a primary mortgage, which means you own your home outright, it is possible that a HELOC is a first mortgage instead.

The bottom line

HELOCs have many advantages. They can give you extended access to cash – and potentially large amounts of it – and you only pay interest on what you withdraw for the first 10 years or so.

Despite these advantages, these products also have some important drawbacks. That is to say, rates and payments can fluctuate and failing to pay on time can put your home at risk of foreclosure. If you’re not sure if you can handle rising payments across the board, you may be better off with a loan that offers fixed rates and payments, such as a home loan.



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