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 exceeds what you owe.
You could borrow against your accumulated equity with a home equity line of credit (HELOC). A HELOC works 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, look at the pros and cons of HELOC.
- What is a HELOC?
- Pros
- Cons
- See All 23 Items
What is a HELOC?
A home equity line of credit, also known as a HELOC, is a type of loan that allows homeowners to borrow money against the equity of their home or related property. A home’s equity is the appraised value minus the amount owed on a mortgage.
For example, if your house is valued at $300,000 and the mortgage is $150,000, you have $150,000 in home equity. That doesn’t mean you’ll be able to borrow $150,000. With a HELOC loan, banks or lenders allow you to borrow against a percentage of your equity, typically up to 75%. So, if your equity is $150,000, you could borrow up to $112,500.
A HELOC works more like a credit card than your typical loan. Once approved, a line of credit will be opened to borrow money from whenever needed. However, HELOCs only allow you to borrow money against that credit line for a predetermined period set by the lender. This is known as the draw period.
Once the draw period ends, you’ll enter the “repayment period,” or the time you must repay the borrowed amount plus interest. You’ll only have to pay back whatever you took out. So if you only borrowed $75,000 of the $112,500 you were approved for, that’s how much you’ll have to repay.
Pros
- Flexible access to funds and repayment
- Lower interest rates
- Higher loan limits
- Potential tax deduction
- Improve credit score if managed responsibly
- It can be used for various purposes
Cons
- Interest rates are usually variable
- Risk of foreclosure
- Potential for overborrowing and overspending
- Lowers your home equity
- Closing costs and fees
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 your home's equity 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 if 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 increase 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 improve 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. If you cannot repay the loan, you could lose your home.
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 don’t make your monthly payments.
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 up-front charges. Your lender may also charge an early payment penalty if you repay your HELOC before it becomes due.
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.
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.
Conclusion
While taking out a home equity line of credit can help consolidate debts, one must consider the HELOC pros and cons to determine if it’s the right fit for their financial needs. A HELOC loan has lower interest rates and higher loan limits than traditional loans. Still, it also comes with variable interest rates and closing costs, such as the appraisal fee needed to determine the home’s value. Home equity loans or a cash-out refinance are other ways to borrow money against your home’s value.
Why You Should Trust Us
Benzinga has offered investment and mortgage advice to more than one million people. Our experts include financial experts and homeowners, such as Anthony O’Reilly, the writer of this piece. Anthony is a former journalist who’s won awards for his coverage of the New York City economy. He’s navigated tricky real estate markets in New York, Northern Virginia and North Carolina.
Frequently Asked Questions
What is a HELOC?
HELOC stands for home equity line of credit, a loan that allows you to borrow money against a percentage of your home’s equity. Equity is the appraised value of a home minus the amount owed on the mortgage. You can borrow money against this line of credit for a set time known as the “draw period” and must repay it, plus interest, during the “repayment period.”
What is the downside to a HELOC?
The downsides of a HELOC include variable interest rates that impact monthly payments, pricey closing costs and the risk of foreclosure.
Can I have a HELOC and never use it?
Yes, you can get a home equity line of credit (HELOC) and never borrow money from it, though depending on your lender, you may incur fees.
What is a good HELOC rate today?
While HELOC rates can change daily, they’re generally based on the prime rate set by the Federal Reserve. As of this writing in January 2025, the prime rate was 7.5% and most HELOC rates were around 8-9%.
About Anthony O'Reilly
Anthony O’Reilly is an updates editor for Benzinga. He’s won numerous journalism awards for his coverage of the New York City economy and Long Island school district budgets.