The Pros and Cons of a Home Equity Line of Credit (HELOC) (2024)

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Pros of HELOCs

There are several reasons you might be interested in using a HELOC. Below are a few of the biggest advantages HELOCs have to offer.

Flexible Access to Funds

Unlike home equity loans, which give you access to a lump sum of cash all at once, HELOCs offer a revolving credit line — much like a credit card. You can withdraw and spend only what you need, as you need it, up to the full HELOC amount. And you’ll only pay interest on the amount you borrow. This makes HELOCs a good potential solution for funding expenses with unknown costs, such as remodels or home additions.

Often Lower Interest Rates

HELOC interest rates tend to be lower compared to credit cards and other unsecured loans. Unsecured lines of credit and loans don’t require collateral. HELOCs, on the other hand, are secured. When you take out a HELOC, your home serves as collateral, giving the lender more incentive to offer you a lower rate. And with a lower interest rate, borrowers can save money when it comes to repaying a loan.

Potential Tax Benefits

Your HELOC may grant you some tax benefits, depending on how you use it. According to the IRS, interest on a HELOC may be deductible if you use the funds to “buy, build, or substantially improve” your home that secures the loan. Before you bank on tax deductions when making home improvements, consult your tax professional about your unique situation.

Many Possible Uses

HELOCs are flexible in that you can use the funds to pay for things like education, emergencies or debt consolidation. And you don’t need to use a HELOC for one single purpose — you can use it for several of these expenses at the same time. Some lenders may even allow you to lock in your interest rate on a portion of your draw if you think rates will continue to rise in the future. Ask your lender about their policies before signing a loan agreement.

Cons of HELOCs

While a HELOC can be a more affordable way for homeowners to borrow money, it comes with risk. Here are some potential drawbacks to consider before taking out a HELOC.

Often Variable Interest Rates

Generally, HELOCs have variable interest rates, meaning the interest rate can fluctuate based on market conditions. While this can be good news if interest rates go down, it can also lead to potential payment increases. Fluctuating interest rates can also make it difficult to know how much borrowing will cost you in the long run.

Risk of Overborrowing

Like a credit card, HELOCs are a form of revolving credit. With some HELOCs, you only need to make interest payments during the draw period. But when the repayment period kicks in, you’ll have to start repaying the loan principal. If you aren’t careful with your borrowing, you may face unaffordable payments when it’s time to repay. You can avoid taking a major hit to your budget by borrowing only what you need and having a plan for repayment once your draw period ends.

Potential for Losing Your Home

With HELOCs, you risk losing your house to foreclosure if you can’t make your payments. To avoid this scenario, only borrow what you know you can afford to repay, and if possible, start paying off the principal during the draw period. When the repayment period kicks in, you’ll have a smaller balance to repay. Always make sure you understand the terms of your HELOC, including rates, terms and penalties, before you sign an agreement.

Closing Costs and Fees

HELOCs can be more affordable than some other types of credit, but keep in mind you’ll pay more than just interest. HELOCs also have a variety of fees that can quickly drive up the cost of borrowing. These can include appraisal fees, application fees, closing costs, annual fees, early termination fees and more. Pay close attention to these fees when shopping for a HELOC. Find lenders that offer loans with fewer fees, or try to negotiate them down before signing an agreement.

Is a HELOC Right for You?

Getting a HELOC can be an accessible way to finance certain expenses or consolidate debt, but it’s not always the best choice. Before you decide to apply for a HELOC, make sure you’re financially prepared. Consider the following before making such a large financial commitment:

Credit score: Your credit score affects your ability to qualify for a HELOC. The higher your credit score, the more likely you are to qualify. If you don’t have good credit, you may not be approved.
Income stability: Since a HELOC uses your home as collateral, it’s important to have a plan for paying it off. Otherwise, you risk losing your home to foreclosure. Having a stable income — and therefore a way to pay off your HELOC — is required by many lenders.
Existing debt obligations: Even though HELOCs can be more affordable than unsecured loans, they still add to your debt burden. Keep in mind you’ll be making HELOC payments on top of your existing mortgage payments. Make sure your existing debt obligations aren’t so much that a HELOC may overextend you.

>> Related: Learn more about how to get the best HELOC rate

Alternatives to HELOCs

If a HELOC isn’t the right choice for you, there are other options when it comes to borrowing.

Personal loan: A personal loan is an option for those who don’t have equity in a home or prefer the idea of an unsecured loan. But personal loans, which are usually unsecured, tend to have higher interest rates than secured loans. Plus, personal loans generally have lower loan amount maximums — though there are some lenders that offer up to $200,000.
Credit card: Credit cards tend to have high interest rates, averaging north of 20%, so you don’t want to put purchases on a card you’re not sure you’ll be able to repay. You can also consider a card with an introductory 0% annual percentage rate (APR), which could be a sound decision if you can pay off your balance before the introductory rate ends.
Home equity loan: A home equity loan is another way to borrow against the equity in your house. But instead of accessing a line of credit to draw on as needed, a top home equity loan provides a lump sum upfront, which you pay back in monthly payments. Home equity loan rates also tend to be fixed, which may appeal to some borrowers.
Cash-out refinance: A cash-out refinance allows you to replace your current mortgage with a larger one. In doing so, you borrow more than you need to pay off your current mortgage and cash out on the rest. You can borrow large amounts at a low interest rate with this option — but you’ll have to pay closing costs, and your debt burden will grow.

Can I use my 401(k) as a HELOC alternative?

While borrowing against your 401(k) loan could help you avoid loan fees and lenders in general, it’s rarely the best option. Spending from your retirement savings may risk your future security, and not all plans allow loans. Plus, you may have to repay the loan in a hurry if you leave your job.

>> Related: Learn more about a HELOC vs. home equity loan vs. cash-out refinance

The Bottom Line

A HELOC can be a strong option for borrowers with significant equity in their homes who meet one or more of the following criteria:

Have a stable income and high credit score
Want a line of credit they can draw from as needed
Want to make improvements to their home and get a potential tax benefit while doing so

On the other hand, HELOCs have risks. Variable interest rates can make it tough to budget for repayment, and securing a loan with your house can be risky as you can lose your home.

Before taking on more debt, weigh HELOC pros and cons and consider your own personal financial situation. If you decide to get a HELOC, do so only after careful planning. And don’t hesitate to consult experts like your financial planner or tax professional before making any big decisions.

>> Related: Learn more about the best HELOC rates

Frequently Asked Questions About HELOC Pros and Cons

It depends on your situation. If you don’t have much equity in your house, or you’re uncomfortable using your house as collateral, a HELOC may not be the best option. Similarly, if you think you may overspend with the ability to draw on your HELOC as needed, something like a smaller personal loan may be better.

A HELOC tends to be harder to get than a mortgage because you need a certain amount of equity in your home in order to qualify. When applying for a mortgage, it’s possible for buyers to avoid having to put 20% down. With a HELOC, however, you need equity in your home to borrow against. Lenders may also be less willing to provide HELOCs and other types of second mortgages because your mortgage loan usually takes priority in getting paid off if you lose your home to foreclosure.

Payments on variable-rate HELOCs can increase over time if the interest rate on your line of credit grows. HELOC payments can also jump significantly when your draw period ends. In addition to making interest payments like you did during the draw period, the repayment period requires you to start repaying the principal — which can dramatically increase your HELOC payments.

Typically, yes. When you qualify for a HELOC and sign the loan agreement, you gain access to the line of credit for the amount for which you were approved. You can withdraw money up to this limit at any time during the HELOC’s draw period. Your lender may disburse the funds via different methods, including by checks, a credit card, an online transfer or even cash withdrawal at a bank.

Editor’s Note: Before making significant financial decisions, consider reviewing your options with someoneyou trust, such as a financial adviser, credit counselor or financial professional, since every person’s situation and needs are different.

If you have feedback or questions about this article, please email the MarketWatch Guides team ateditors@marketwatchguides.com.