HELOC Pros And Cons: What You Should Know

*Our sister company Rocket Mortgage^® does not currently offer HELOCs.

If you’re considering a significant kitchen renovation, adding a primary bathroom or relieving the burden of high-interest credit card debt, a home equity line of credit (HELOC) may be a good option for you. A HELOC is similar to a credit card, with your home equity serving as the credit limit.

However, as with all home equity loans, HELOCs have their own advantages and disadvantages. Whether a HELOC is the ideal choice for your needs depends on what you’re trying to finance and your comfort level using your home as collateral.

Pros And Cons At A Glance

To get us started, let’s take a look at some of the most notable HELOC pros and cons.

What Is A HELOC?

A HELOC is one way to refinance a home to consolidate debt. It allows homeowners to borrow money against the equity they have in their home as a line of credit. Borrowers can use HELOC funds for a variety of purposes, including home improvements and remodeling, education and the consolidation of high-interest credit card debt.

How A HELOC Works

With a HELOC, your property serves as collateral for the credit line. As you repay the outstanding balance, your available credit limit is replenished, similar to how a credit card is used. This means that you can typically tap into these funds as needed during your draw period, which usually spans approximately 10 years and is limited by the credit limit established at the beginning of your loan. Following the draw period, the repayment phase starts. Repayment usually lasts up to 20 years.

Repaying A HELOC

Just like with a credit card, you’ll have a monthly payment to your lender until you pay off the loan amount and interest. Before you apply for a HELOC, be sure you know the specific terms and conditions you’re agreeing to. For instance, HELOCs have variable interest rates. It’s possible that you could borrow money to refinance debt while your HELOC rate is low, but eventually, you could end up paying a higher interest rate on your HELOC than you had on your original debt.

HELOC Pros And Cons

With any sort of loan, there will be pros and cons. Here are some to consider when deciding whether or not to apply for a HELOC:

HELOC Pros

• Flexible borrowing: During the draw period of your loan, you generally only need to cover the interest on the amount you've borrowed. However, you have the option to make additional payments, and these extra funds will go toward reducing the principal balance of your borrowed amount. This proactive approach will result in a reduced balance to repay during the loan's repayment period, ultimately lowering your overall payment.
• Varied repayment options: You have a few different options when it comes time to repay your HELOC. The first option is to convert your HELOC. If you have a HELOC with a variable interest rate, you may be able to convert a portion or the entirety of your outstanding balance into a fixed-rate loan. This transition will result in consistent monthly payments throughout the repayment period, making it more convenient for budgeting.

Another option is to renew your HELOC. Certain HELOCs offer the option to renew your credit line as the draw period ends. This involves reapplying for a new HELOC and using its funds to settle the previous one. At that point, you’d enter a fresh draw period, meaning you’d still be paying only the interest on the borrowed amount.

One more option is to refinance your HELOC. If your home has a sufficient amount of equity, you might be able to refinance your HELOC using either a home equity loan or a cash-out mortgage refinance.

• Potential credit score boost: The impact a HELOC can have on your credit score is similar to how credit card repayments work. If you make your payments on time, it will help your credit score. However, if you make a late payment, your credit score can go down. Your credit score may also take a hit initially when they perform a credit check when you apply for the loan.
• Possible tax deductions: A HELOC can provide benefits during tax season, as the interest you pay on a HELOC may be eligible for tax deductions. You can claim an interest deduction on a HELOC if you're utilizing the funds to construct, purchase or significantly enhance your home. This rule was introduced in the 2018 tax year and remains in effect through the 2025 tax year.

HELOC Cons

• Reduced equity: A HELOC will reduce the amount of equity you have in your home. For instance, if you currently owe $150,000 on your primary mortgage and your home has a value of $300,000, you have $150,000 in equity. However, if you decide to obtain a HELOC for $60,000, your equity will decrease to $90,000. This is calculated as the initial $150,000 equity minus the $60,000 borrowed through the HELOC.
• Risk of foreclosure: A HELOC is an example of a secured loan, one that is backed by a form of collateral. In a HELOC, your home is your collateral. So, if you fail to make your payments or fail to make them on time, you could risk losing your house through foreclosure. Make sure before taking out the loan that you can afford to make your payments on time, especially when your HELOC reaches its repayment period.
• Variable interest rate (usually): The majority of HELOCs come with variable interest rates. That means these rates can fluctuate over the course of your loan, either increasing or decreasing depending on the economy. This variability can bring complexity to budgeting for HELOC payments. Given that the interest rate is subject to change, your monthly payment may also experience fluctuations. It is crucial to ensure, prior to obtaining a HELOC, that you have the financial capacity to manage your monthly payments, even if there is a possibility of an increase.
• Potential for overspending: Since a HELOC operates as an open line of credit, homeowners are susceptible to the temptation of overspending. Similar to a credit card, you have the freedom to borrow as much as you desire, up to your established credit limit. This accessibility can make it effortless to accumulate substantial debts, so it’s important to make sure you have a well-structured plan to avoid excessive borrowing.

HELOC Alternatives

A HELOC isn’t the only choice you have when it comes to borrowing money:

• Home equity loan: Like a HELOC, a home equity loan is a type of loan that is based on the amount of equity you’ve built in your home. A home equity loan is a good choice if you already know exactly what you need money for and how much you need.
• Cash-out refinance: You might also choose a cash-out refinance. In this type of refinance, you borrow more than what you owe on your existing mortgage, receiving the leftover funds as a single payment. You’ll pay back what you borrow with regular monthly payments with interest. This can also be a good choice if you need a specific amount of money for a planned home improvement project.
• Personal loan: With a personal loan, you’ll receive a single payment that you repay each month with interest. You can use the money from a personal loan for whatever you’d like. A personal loan is not backed by collateral. But, be aware that personal loans typically come with higher interest rates than HELOCs. You may not be able to borrow as much, either.

HELOC Vs. Home Equity Loan Vs. Cash-Out Refinance

With a home equity loan and cash-out refinance, instead of having a draw period, you’ll receive your money in a single payment that you pay back monthly with interest. A home equity loan limits you to borrowing only from the equity you have in your home. A cash-out refinance could potentially let you borrow more than the equity in your house, but still comes as one single payment to you. A HELOC, home equity loan and cash-out refinance all use your home as collateral.

How To Get A HELOC

Getting a HELOC is similar to getting other mortgage loans. You’ll need to have reliable income, good credit, at least 15% – 20% home equity, a responsible payment history and a low debt-to-income ratio (DTI). If you meet all of these qualifications, you’ll need to find a lender and gather personal documents, such as bank statements and W-2s (this may vary depending on your lender). You’ll also need to get a home appraisal to find out how much your home is worth. Once you’ve been approved for a HELOC and close on your new line of credit, you’ll start the draw period where you can draw funds from your loan.

FAQs About The Pros And Cons Of HELOCs

Keep reading to see several frequently asked questions about the pros and cons of HELOCs.

Is there a downside to getting a HELOC?

Yes. As we said above, some of the downsides can be reduced equity in your home, risk of foreclosure, variable interest rates and the potential for overspending.

Are HELOCs ever a good idea?

They can be. If you qualify for a HELOC, it can help you with a flexible option to borrow money and give you several repayment options, which may work out better for you than some of the other loans we’ve talked about.

What is the monthly payment on a $50,000 HELOC?

This can vary, depending on your interest rate and the terms between you and your lender. Just remember, the monthly payment may be low while in the draw phase but may increase quite a bit during the repayment phase if you have a flexible interest rate.

Is it smart to get a HELOC right now?

It can be. HELOCs are a good way to borrow money you need now for things like home renovations or credit card consolidation. And they give you the option to pay that loan back in several different ways.

How do I know if a HELOC is right for me?

It depends. Take a look back at some of the qualifications to apply for a HELOC and do some research on other types of loans. Reaching out to different lenders can also help you find out if it’s a good idea for you right now.

The Bottom Line: HELOCs Can Be A Flexible Way To Get Cash

Whether you ultimately decide to apply for a HELOC or not, it’s good to know your options when it comes to loans. HELOCs can be a nice option because they’re a flexible way to get cash. You may find that alternative options, such as a cash-out refinance or home equity loan, are a better fit. Visit our friends at Rocket Mortgage to get approved for a cash-out refinance that can fund a home improvement project.