July 11, 2023
What Are the Pros and Cons of a HELOC?
A home equity line of credit (HELOC) is a line of credit based on the equity you have in your home. Like other lending options, there are advantages and disadvantages. That means it can be a great tool for the right situation – but not necessarily for every situation. Following are some HELOC pros and cons so you can determine if it’s the right option for you.
Access your home equity
You’ve built equity by making on-time mortgage payments and increasing your property’s value. Want to put those funds to work to further your financial goals?
PRO: Get the cash you need – now
Like a home equity loan or cash out refinance, a HELOC allows you to tap into your hard-earned equity for a variety of needs. Using one can shave off years of saving for home improvement costs or making a down payment on a second home.
CON: Based on property value
Borrowing against your house also comes with risk. It's possible your home can lose value over time and you have leveraged equity that may no longer exist. When it comes time to sell your home, you would need to make up for that lost equity at closing.
No restrictions for how to use funds
Unlike many other loan types, there are no rules about what HELOC funds can be used for. It’s recommended to use your equity to add value to your home or improve your finances, but there are no limitations in place for how to use the cash.
Imagine you’re planning to use your HELOC to finish your basement. Just as you’re getting started with the project, your car breaks down. Fortunately, if you don’t have an emergency fund, you can draw on your credit line to cover the cost of repairs or a new vehicle plus building supplies. Or, if your project comes in under budget, you could use the extra funds to consolidate or pay off high-interest debt.
CON: Requires discipline
Let’s be real: When options are endless, it can be tempting to use your equity in ways that might not serve you in the future. Consider making a plan for the funds ahead of time. What kind of purchases are acceptable and what are not?
Home is used as collateral
Like a home equity loan, a HELOC uses your home as collateral to access your equity. That means your property serves as a guarantee to repay the loan.
PRO: Lower interest rates
Because you’re securing the loan with your home, HELOCs typically offer lower interest rates than unsecured credit options like credit cards and student loans. Just keep in mind rates also depend on credit score and loan terms.
CON: Risk level
Putting up your home as collateral requires a solid repayment plan and some level of risk tolerance. But even the most meticulous budgeting and saving isn’t 100% bulletproof. If something happens to cause you to default on the loan, your lender can take and sell your collateral to recoup the money they’re owed. Borrow with care.
Cash available as a line of credit
You can access funds when you need them over a set period of time, often 10 years. Depending on your lender’s offerings, you may be able to use HELOC funds by paying with checks, a card, or account transfer. Some lenders require a minimum balance or a minimum withdrawal from your account every year of the draw period.
CON: Requires more discipline
Again, convenience and flexibility can sometimes make it too easy to spend. Incorporate HELOC funds into your budget to avoid unintentional spending.
Flexible repayment terms
A HELOC has two periods: the draw period and the repayment period. During the draw period, you can access the cash whenever you want it, and the payments you make during this time are interest-only. When you reach the repayment period, you begin making regular monthly payments with principal and interest.
PRO: Interest-only payments
With a HELOC, you may be able to adjust your payment schedules as necessary. It may even be possible to reduce your payment to interest-only for a period of time during the repayment period and then pay off the balance when you are more financially secure.
CON: Can create a deeper hole
If you don't pay down the principal, you will continue paying interest without reducing your overall debt. This will take longer to pay off and makes it cost more overall.
Variable interest rates
Interest rates can be fixed or variable. HELOCs typically start with a low introductory rate and then become variable. That means the rate can fluctuate with the market.
PRO: Reputation for favorable rates
Despite the uncertainty, a HELOC’s interest rate is often lower than other loan types. Plus, rate caps are in place to avoid significant rate increases.
CON: Harder to budget
Interest rates increasing or decreasing with market forces makes it hard to know your payments up front. This can make it harder to budget for monthly expenses.
Possible tax advantages
Just like your primary mortgage interest, you may be able to deduct your HELOC interest if you itemize on your annual tax return.
PRO: Potential savings
Typically, a HELOC interest is tax deductible if the funds are used for home improvements or to buy a property. Be sure to talk to a tax advisor and document your purchases before pursuing this option.
CON: Not a given
The Tax Cuts and Jobs Act of 2017 changed the home interest deduction, including the tax deductions offered by home equity lines of credit. However, your HELOC may still offer tax advantages depending on how you use it.
Home equity line of credit – pros and cons
Here’s a quick recap of some of the advantages and disadvantages of a HELOC.
Take only as much money as you need, as you need it, during the draw period
Variable interest rate may increase with the market
Pay interest only on the amount you draw
Fluctuating monthly payments can make it hard to budget
Low introductory interest rate
Revolving line of credit can be tempting to use for unintended purposes
Acts like a credit card but often with a higher balance and lower interest rate
Risk of foreclosure because home is used as collateral
There are pros and cons of using home equity in all forms, including HELOCs, home equity loans, and refinances. Of all the options, HELOCs are favored for their convenience and flexibility. You access the funds only as you need them and pay only for what you borrowed – a great solution if you have one or more ongoing projects and don’t know the total costs up front. If you still aren’t sure which way to turn, talk through your options with a trusted loan officer.