HELOC Pros and Cons: Is a Home Equity Line of Credit Right for You?
A home equity line of credit (HELOC) allows you to tap your home’s equity, but it’s not the right tool for every goal. HELOCs come with the flexibility to access funds repeatedly instead of taking one lump sum, but that flexibility comes with significant trade-offs: variable interest rates, fluctuating payments and the risk of losing your home if you can’t repay what you borrow.
Understanding HELOC pros and cons can help you decide whether this financial product fits your plans and budget.
- You’ll draw funds as needed with a HELOC and only pay interest on what you use, but missed payments put your home at risk.
- Your monthly payment can rise if interest rates increase and once the draw period ends and repayment begins.
- A HELOC works best for a defined need and clear repayment plan, but is usually a poor choice for nonessential spending, recurring bills or borrowing without a plan to pay down the balance.
What is a HELOC?
A HELOC is a revolving credit line that functions similarly to a credit card: You can make purchases up to your limit, pay off the balance and then continue to use the credit line.
How it works: You can access the HELOC as needed during the “draw period,” which is typically five to 10 years. After that, the repayment period begins and you’ll no longer have access to the credit line.
Repayment: While it’s common for HELOCs to come with low, interest-only payments during the draw period, you must make full principal-and-interest payments during the repayment period.
Read more about common HELOC requirements.
What are the pros of a HELOC?
- You’re likely to get a competitive rate. HELOC rates are typically much lower than rates on personal loans or credit cards because HELOCs are secured by your home.
- You’ll get access to a credit line you can use repeatedly. HELOCs often come with a card you can swipe, like a credit card. This makes it easy to access your credit line frequently.
- You only pay interest on the amount you use. Unlike with a lump-sum loan, you won’t have to pay interest on the total amount starting on day one. You’ll only pay interest on funds you draw, not the full credit limit.
- You may be able to make interest-only payments during the draw period. It’s common for HELOCs to allow for interest-only payments during the draw period, which can mean low payments that don’t have as big an impact on your monthly budget during that time.
- Your interest may be tax-deductible in some cases. If you used the HELOC funds to “buy, build or substantially improve” your home, IRS rules allow you to deduct any HELOC interest you paid from your taxable income.
- You may qualify to convert some of your HELOC into a fixed rate. Some lenders allow you to take a portion of the funds allowed under your HELOC limit and “lock” it at a fixed rate so that you’re exposed to less fluctuation in your interest rate and payments.
- You can usually close on a HELOC quickly. It’s possible to get your funds in as little as five to seven days if you search for lenders who specialize in fast HELOC closings.
What are the cons of a HELOC?
- Your monthly payments can increase at any time. Because HELOCs have variable interest rates, they fluctuate with the broader market. If you want a stable payment, a HELOC likely won’t be a good choice for you.
- You may be tempted to overspend on nonessentials. Having access to a credit line, especially one with interest-only payments during the draw period, can make spending feel convenient and easy. The low impact a purchase has during the draw period can become a larger burden once full repayment begins.
- You may experience payment shock when the draw period ends. It’s not unusual for HELOC payments to spike sharply — sometimes by 150% or 200% — once the repayment period begins. This is known as “payment shock” and, for unprepared homeowners, can be one step on the path toward foreclosure.
- Your home is on the line. If you can’t make your HELOC payments, your lender could foreclose on the home you used to secure it.
- You could drain your home equity. Since the HELOC essentially converts some of your home equity into usable funds, using a HELOC reduces your available home equity. That can cause complications when you go to sell or refinance the home, or make it difficult to take out additional financing secured by the home.
- You may have to pay fees. There are several types of fees that can catch HELOC borrowers off guard. For instance, you may have inactivity fees if you don’t use the credit line frequently enough, required annual membership fees, or early cancellation fees you’ll owe if you pay off your HELOC within a few years of taking it out.
HELOC rates vs. other equity loan options
How to decide whether a HELOC is right for you
A HELOC may be a good fit if …
- You have a clear, necessary use for the funds. Home improvements, renovations, emergency expenses, or another defined financial need can be a great way to use a HELOC — as long as you have a solid plan for how you’ll repay the debt.
- You need funds over time. A HELOC’s flexible, reusable credit line can work well for phased projects like a DIY renovation or education expenses. It may not make as much sense for one large, upfront expense.
- You have a stable income and room in your budget. You need to be able to make your HELOC payments even if interest rates rise or you end up using more funds than you initially planned.
- You’re comfortable using your home as collateral. Missing payments can put your home at risk, and this isn’t something to take lightly. Borrowing against a home should be limited to an amount you know you can repay.
A HELOC may not be the right fit if …
- You’re already carrying significant debt. Many homeowners who take out a HELOC don’t own their home outright, but if your primary mortgage is already taking a big bite out of your budget, adding a HELOC can become a big strain. If you’re also carrying credit card balances, student loans or other significant debt, it can become very tough to manage all of your obligations.
- You really only need one fixed amount of money. If you know exactly how much you need, it can be cleaner to take out a fixed-rate loan. Its consistent payments and single payout are simpler to manage and can help reduce the temptation to overspend.
- Your budget can’t absorb higher payments. Most HELOCs’ payments will increase over time. If you’re not financially or emotionally ready for that, don’t put yourself in that position.
- You plan to sell soon. If you sell your home, the outstanding HELOC balance will usually come due in full at closing. That can be a big burden if it reduces the cash you walk away with or triggers additional HELOC fees (early closure fees, for example).
- You’re uncomfortable putting your home at risk. If you can’t repay the balance, the lender may be able to foreclose on your home.
Frequently asked questions
A HELOC can be a useful tool for debt consolidation if you have high-interest debt, but only if you truly have all of your ducks in a row: you’ll need stable income, significant home equity and a realistic payoff plan. The major downside? You’re converting unsecured debt (like credit cards) into debt your home secures. That’s riskier debt, especially if you aren’t certain you can resist the temptation to rack up more debt with a loan as open-ended and flexible as a HELOC.
The application usually creates a hard inquiry, which can drop your credit score by a few points. Once you’re approved, the new account and its balance will affect your credit utilization and payment history. However, making on-time payments will also positively affect your credit score.
Neither is better, as the right choice depends on your financial situation and needs. A home equity loan gives a lump sum with fixed, predictable payments, and those features can be particularly helpful when you’re trying to consolidate debt.
Yes. A lender may reduce or freeze the credit line if the home’s value falls or your credit tanks. That’s one reason it’s not usually wise to think of a HELOC as an emergency fund. However, you can still seek out another HELOC lender if your current lender reduces or freezes your loan.
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