HELOCs offer flexible access to funds with lower interest rates and potential tax deductions, but come with risks such as foreclosure, variable interest rates, and overborrowing.
Do you need to borrow money to improve your home or consolidate lingering debts? With home prices on the rise, you may be able to unlock its equity if you are a homeowner. You have equity in your home when its value is greater than what you owe.
You could borrow against your accumulated equity with a home equity line of credit (HELOC). A HELOC works much like a credit card where you can withdraw only what you need and use the money for any purpose. If you need some extra cash, take a look at the HELOC pros and cons.
Overview: Pros and Cons of Home Equity Line of Credits (HELOCs)
| Pros | Cons |
| Flexible access to funds and repayment | Interest rates are usually variable |
| Lower interest rates | Risk of foreclosure |
| Higher loan limits | Potential for overborrowing and overspending |
| Potential tax deduction | Lowers your home equity |
| Improve credit score if managed responsibly | Closing costs and fees |
| Can be used for various purposes |
Pros of a HELOC
If you are looking to borrow money, consider some of the benefits a HELOC has to offer:
Flexible Access to Funds and Repayment
With a HELOC, you can borrow money as you need it. You save money because you don’t pay interest on the funds until you withdraw them.
Lower Interest Rates
Since the equity in your home secures your HELOC, you may get a lower interest rate than you would with other types of financing, such as credit cards or personal loans.
Higher Loan Limits
The amount you can borrow with a HELOC depends on how much equity you have built up in your home. A sudden rise in the market value of your home can improve your equity standing. Or if you have made a substantial dent in paying down your mortgage.
If you’ve built up a significant amount of equity in your home, you may be able to take out a larger loan than you could with other forms of financing.
Potential Tax Deduction
The interest you pay with a HELOC may be tax-deductible when you use the money to buy, substantially improve, or build your home.
Improve Credit Score if Managed Responsibly
Taking out a HELOC can improve your credit score as long as you make timely payments. Your credit utilization ratio may improve if you use funds from HELOC to pay off high-interest credit cards. Swapping credit card debt with a secured line of credit may improve your credit mix and bump up your credit score.
Can Be Used For Various Purposes
The money you borrow through a HELOC isn’t restricted, so you can use the funds as you want. Whether you use the cash to consolidate debt, take a vacation, or make improvements to your home, the decision is up to you.
Cons of a HELOC
Depending on your financial situation, taking out a HELOC can have drawbacks.
Interest Rates Are Usually Variable
HELOCs typically have adjustable interest rates. Your monthly payment can change as interest rates rise and fall.
Risk of Foreclosure
Your home serves as collateral for a HELOC. You could lose your home if you cannot repay what you have borrowed.
Homeowners should carefully consider foreclosure risk before taking out a HELOC. As interest rates rise or you enter the repayment phase of your HELOC, your monthly payment goes up.
If your income isn’t sufficient, you could lose your home if you can’t make your monthly payment.
Potential for Overborrowing and Overspending
HELOCs are usually structured in two phases: draw and repayment. HELOCs typically let you make interest-only payments during the draw period. The draw period could last several months or years, depending on the terms of your HELOC.
As you make interest-only payments monthly, you may not feel the financial ramifications of drawing money from your HELOC. Interest-only payments can make it easier to justify taking out more funds. Yet once you start paying back the principal, you could find a much higher monthly payment than you planned.
Lowers Your Home Equity
Your home equity is the difference between the market value of your home and what you still owe. With a HELOC, the equity in your home drops because you are borrowing against it. If the value of your home drops, you could end up owing more on your home than what it is worth.
Closing Costs and Fees
HELOCs come with added costs and fees. Borrowers often pay an application fee, appraisal fee, closing costs, and other upfront charges. Your lender may also charge an early payment penalty if you repay your HELOC before it becomes due.
Should You Get a HELOC?
When you have sufficient equity in your home, taking out a HELOC may make sense if you prefer to borrow and pay interest only on what you need. You can use the funds as you need to and get a better rate than other types of financing.
Before taking out a HELOC, consider your income and financial situation. When interest rates rise, so will your monthly payment. Once you reach the repayment period, you will begin paying back the principal. You could lose your home if you cannot afford the monthly payment.
Compare the Best HELOC Providers From Benzinga’s Top Providers
Unlock the equity built up in your home by taking out a HELOC. Below are some of the best lenders for home equity lines of credit based on the products offered, application process, fees charged, loan-to-value ratio, and time to close.
- Best For:Online MortgagesVIEW PROS & CONS:securely through Rocket Mortgage (formerly Quicken Loans)'s website
- Best For:Flexible Mortgage OptionsVIEW PROS & CONS:securely through Angel Oak Mortgage Solutions's website
- Best For:Self-employed BorrowersVIEW PROS & CONS:securely through CrossCountry Mortgage's website
Alternatives to a HELOC
Before you borrow money through a HELOC, consider some alternative forms of financing.
Home Equity Loan
You borrow against the equity you have built up with a home equity loan. Unlike a HELOC from which you take draws, you receive one lump payment with a home equity loan. You make monthly principal and interest payments over a fixed term like an installment loan. Home equity loans typically have fixed interest rates, so your payment stays consistent over time.
Cash-Out Refinance
Like a home equity loan, you can take out the equity in your home as one lump payment with a cash-out refinance. However, you don’t take out a second mortgage. Instead, you replace your primary mortgage with one that reflects your new borrowed amount. You can save money if you refinance at a lower interest rate than you currently pay.
Personal Loan
A personal loan is unsecured and repaid over time. Since no collateral is required, lenders may look closer at your debt-to-income ratio and credit score when deciding whether to loan you money. Personal loans usually have higher interest rates than other secured financing.
Consider a HELOC When You Need to Borrow Money
If you are a homeowner, a HELOC may be the right solution if your home has sufficient equity. HELOCs offer flexibility, and lower interest rates, and may even bump up your credit score.
You put your house on the line with the HELOC. Remember that your monthly payment jumps up as interest rates rise or you enter the HELOC’s repayment phase. If your income can’t keep up with your increased monthly payment, you could lose your home if you fall behind.
Frequently Asked Questions
Is a HELOC a second mortgage?
You take out a second mortgage with a HELOC. You’ll have two separate mortgage payments to make each month. However, taking out a HELOC becomes your primary mortgage if you have previously paid off your home.
Can you pay off a HELOC early?
Some lenders charge a prepayment penalty to pay back your HELOC early. The lender may assess a penalty for fully repaying your HELOC before it becomes due. Consider your HELOC’s early payment penalty, especially if you plan to sell your home soon.
Can I sell my house if I have a HELOC?
Your house serves as collateral for a HELOC. If you sell your house, your HELOC gets paid off from the proceeds of the sale. When the money from the home sale isn’t enough to fully repay a HELOC, the borrower must pay the shortfall at the time of closing.