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

A home equity line of credit, or HELOC, is a popular financing option for homeowners looking to leverage the equity they have in their homes. Unlike a traditional loan, a HELOC provides a revolving line of credit that allows you to borrow against your home’s value as needed, offering flexibility for various expenses such as home improvements, debt consolidation or emergency funds. However, like any financial product, a HELOC has both advantages and disadvantages. Here, we compare the pros and cons of a HELOC so you can make the right decision for your home.

A financial advisor can help you evaluate whether or not a HELOC makes financial sense for you.

What Is a Home Equity Line of Credit (HELOC)?

A home equity line of credit is a form of secured financing that allows homeowners to borrow against the equity they have built up in their property. Equity is the difference between the home’s current market value and its remaining mortgage.

A HELOC provides access to funds based on a percentage of this equity, typically up to 85% of the home’s appraised value, minus any outstanding mortgage balance. HELOCs are often used for significant expenses, such as home renovations, educational costs or medical bills, due to the flexibility they offer in accessing funds. They can also be used to build wealth, make a down payment or establish an emergency fund.

Unlike a traditional home equity loan that provides a lump-sum payment, a HELOC functions as a revolving line of credit, similar to a credit card. Homeowners can borrow as much as needed within their approved limit, and they only pay interest on the amount they borrow. HELOCs typically have variable interest rates, meaning the rate can fluctuate over time based on market conditions.

How Does a HELOC Work?

A HELOC operates in two phases: the draw period and the repayment period.

During the draw period, you can access funds up to your credit limit, repaying only the interest on the amount you borrow. This period usually lasts five to 10 years. For example, if you are approved for a $50,000 HELOC with a 10-year draw period, you can borrow and repay any amount up to that limit, making payments based only on the interest due on the borrowed balance. This feature makes a HELOC a flexible option for expenses that may arise sporadically over time.

Once the draw period ends, the HELOC transitions into the repayment period, which often spans 10 to 20 years. During this phase, no additional funds can be borrowed, and you will need to start repaying the principal along with any remaining interest. Repayment amounts can vary, especially if the HELOC has a variable interest rate that fluctuates over time. Depending on the lender’s terms, it may also be possible to convert some HELOCs from a variable to a fixed-rate HELOC.

However, because a HELOC is secured by your home, failing to make payments could result in foreclosure, so it is essential to understand the terms and plan for repayment.

Pros and Cons of HELOCsl

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

A HELOC offers unique benefits and drawbacks that should be carefully considered:

Pros of a HELOC

Flexibility in accessing funds: With a HELOC, you can borrow only what you need when you need it, within the credit limit. This makes it ideal for ongoing expenses like home improvements or emergencies.
Interest-only payments: During the draw period, many HELOCs require interest-only payments on the amount borrowed, which can make monthly payments more manageable.
Lower interest rates: HELOCs often have lower interest rates than unsecured loans, such as personal loans or credit cards, since they are secured by your home.
Tax deductible interest: If you use HELOC funds for home improvements, the interest paid may be tax deductible, potentially lowering the overall cost of borrowing. Before proceeding, it is best to consult a tax advisor for specifics.

Cons of a HELOC

Variable interest rates: Many HELOCs have variable rates, meaning payments can fluctuate and increase over time, making budgeting more difficult.
Risk of foreclosure: Since your home serves as collateral, failing to make HELOC payments could lead to foreclosure, posing a significant risk if you cannot repay the balance.
Possible fees and costs: Some HELOCs come with fees, such as application fees, annual fees or closing costs, adding to the overall cost of borrowing.
Temptation to overspend: The flexible credit line may lead some borrowers to overspend, potentially resulting in higher debt levels that could be challenging to repay during the repayment phase.

HELOCs vs. Home Equity Loans

While both HELOCs and home equity loans allow homeowners to tap into their home’s equity, they function differently.

A home equity loan provides a lump-sum amount with a fixed interest rate and fixed monthly payments, making it a good option for one-time expenses with predictable costs. In contrast, a HELOC offers a revolving line of credit with variable interest rates, providing more flexibility for expenses spread over time, such as ongoing renovations or unexpected costs.

The key difference between HELOCs and home equity loans lies in how funds are accessed and repaid. A home equity loan has fixed monthly payments, making budgeting easier, as you will know the exact amount you owe each month. However, with a HELOC, your monthly payments can vary, particularly if the interest rate fluctuates. A HELOC also allows you to borrow multiple times during the draw period, whereas a home equity loan provides a one-time disbursement.

Choosing between HELOCs vs. home equity loans all depends on your financial needs and how you plan to use the funds, as well as your comfort level with variable vs. fixed payments.

Bottom Line

A HELOC can be a valuable tool for homeowners needing flexible access to funds. While HELOCs offer advantages like lower interest rates and interest-only payments during the draw period, they also carry risks, including variable rates and potential foreclosure. Make sure you understand how HELOCs work, evaluate the pros and cons of a HELOC, and compare them to home equity loans so you can make an informed decision that aligns with your financial goals and needs. A HELOC can provide financial flexibility, but it is also essential to borrow responsibly and plan for repayment so you can protect your investment in your home.

Tips for Real Estate Investing

Deciding how to use your investment equity, as well as deciding to make large purchases such as a home, can be daunting. A financial advisor can take each into consideration of your larger financial plan and help you decide the right path forward. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Before making any changes to your mortgage, make sure to utilize a mortgage calculator to help you see what you’re getting yourself into.