There are many things I like about HELOC (Home Equity Line Credits). However, this borrowing tool also carries risks. You must post your house as collateral and pay interest at a fluctuating rate. This means that it could rise and dramatically boost your repayments. Let’s take a look at all the pros and cons of HELOC.
What are the advantages and disadvantages of HELOC?
Home Equity Line of Credit’s Benefits
Low interest rates
Mortgage rates have risen dramatically overall since 2022, but HELOC rates still tend to be lower than credit card and personal loan rates. If you qualify for the highest rate, HELOC could be a cheaper way to consolidate your debts or lend home renovations.
Flexible Terminology
With HELOC, you use the funds as needed, then repay (interested) only what you borrow. If you need less cash than you think, you may have less repayments. In contrast, home equity loans and personal loans offer lump sums that you need to pay off completely (and also with interest) whether you use all your money or not.
Most home equity lenders also offer flexibility in how they access HELOC funds, including debit cards, checks, ATM withdrawals, and online transfers. Furthermore, there is one that can convert all or part of the HELOC balance into a fixed rate during the draw, so there is no risk of hitting higher interest later.
Another point of flexibility: repayment. Many lenders also offer interest-only HELOCs. This will make payments easier to manage. Of course, you can always choose to repay the principal to all or part of it.
Possibility of tax deductions
Even after the 2017 Tax Reductions and Employment Act, if you use money to renovate your home, you can deduct any interest paid to HELOC. Specifically, the IRS allows deductions on interest when HELOC funds are used to “purchase, build or substantially improve housing. However, based on the total mortgage liability, the deduction can only be obtained up to a certain threshold. Also, the deduction must be itemized to exploit this amortization.
Potential credit boost
Two of the most important components of a credit score are payment history and credit mix. Adding HELOC to your history and paying it on time will help you improve your score. (Please note, however, that increasing your debt load by assuming HELOC can actually reduce your score.)
High loan restrictions
HELOC supplies at least five digits. In many cases, $10,000 is the smallest credit line you can establish. Also, many lenders require at least so many minimum initial withdrawals.
However, how big the credit line is depends on the fairness of the home, that is, you own it entirely. Generally, you can borrow up to 80% of your stock interest, depending on your lender and your finances.
However, a good mortgage also affects the amount of stock you can tap. When the lender says you can borrow up to 80%, they mean the total all Your home base (current mortgage and new HELOC) cannot exceed 80% of your home’s value. Financially, this is called your Combined Loan and Value Ratio (CLTV).
Cons of the home equity credit line
Rate fluctuates
Home equity loans come with a fixed rate, while HELOC has a variable rate. This means that it could rise or fall based on the economic situation, the Fed’s monetary policy, and other factors. This will affect your payments. Even if you take out HELOCs at lower interest rates, you can still face much higher interest rates when it’s time to pay them back.
“Fluctuating interest rates can turn payments into financial roller coasters,” warns Linda Bell, a senior writer for Bankrate’s home lending team. “What starts as a bill you can handle can quickly spiral into unruly debts and put your home at risk.”
The house is in the queue
HELOC is a safe loan. In other words, they have collateral to back it up. Specifically, it’s your home. It is this collateral that allows lenders to charge less interest. However, that also means risk to you. You have your home on the line as a guarantee. “You rent your home, so if you can’t make monthly payments, you put foreclosure at risk,” says Sean Murphy, vice president of mortgage operations, which will close at the Navy Federal Credit Union.
Reduce equity cushions
When you rent through HELOC, you are borrowing against the fairness of your home. If home prices and property values drop, your home may end up for more than it is worth. Furthermore, if your home is your biggest asset, linking your equity with HELOC may limit additional opportunities to borrow as it drains your net worth.
Possibility to quickly perform balance
Many HELOCs allow interest-only payments during the draw period, making it easy to access cash without considering the financial impact. “If the borrower doesn’t return the funds to this line of credit, the loan will eventually begin to amortize and payments will start to rise significantly,” said Joseph Polakovic, owner and CEO of Castle West Financial, a San Diego retirement company. Bottom line: If you don’t expect a monthly payment jump/you don’t have a budget, when the repayment period begins, an unwelcome surprise awaits you.
Additional charges and fees
HELOCs generally have lower closing costs than home equity loans (without many general expenses such as title insurance). However, be aware of other charges that can be added immediately. In most cases, to open a credit line you will need to pay an origination fee to open an annual fee to keep the line open. Lenders may charge to freeze interest rates in part of the draw. You may also be charged early cancellation penalties, inactive fees if you don’t withdraw funds frequently, or (oppositely) the lender may be charged (oppositely) the fee, although it may vary by lender.
“This underscores the importance of shopping with lenders and comparing prices,” Bell says. “Some costs aren’t set on stone. Lenders want your business so maybe they can negotiate some of them before signing on the dotted line.”
Should I get a HELOC?
HELOCS is ideal for those who need cash access for a long period of time, especially if you don’t know how much you need, for example for a multiphase home remodel that can last for months or years. They can also work at a more specific cost with some degree of regularity, such as a child’s university tuition bill or a continuous set of medical care.
If you’re looking for something to use as you go and are looking to pay only for what you borrowed when you borrow it, HELOC is probably a better option than a lump sum home equity loan, says Murphy.
However, Helocs can be dangerous. Various interest rates can rise and if for some reason you can’t pay off your loan, you could lose your home. Plus, it can lead to a false sense of bottomless funds during the draw period.
HELOC alternatives
Here are some loan alternatives that will take into consideration whether HELOC is not for you.
- Home Equity Loan: Home equity loans are similar to HELOC, but offer lump sum payments instead of a line of credit. Repayments begin immediately at a fixed interest rate. This means that monthly payments never change. If you know exactly how much you need in advance and plan to use it immediately, a home equity loan could be a better option than Helock.
- Refinance cash out: A cash-out refinance replaces your existing mortgage with a new loan with a larger balance. You will receive a difference in the money you are ready, in an amount based on the capital of your home (many lenders can borrow up to 80% of the value of your home). Generally, cash-out refi is a good idea if you can get a lower interest rate, afford to pay the closing costs, and plan to stay at your home for a long time.
- Personal loan: Like a home equity loan, personal loans are prepaid with a certain monthly payment, a fixed interest rate, and lump sum amount. The big difference between these loans and HELOCs is that personal loans are unsecured. Therefore, there is no need to place your home or other assets as collateral. The catch is that they tend to have a higher interest rate than HELOC and you may not be able to borrow that much.
Heloc Pro and Cons conclusion
Home Equity Credit (HELOCS) is an option for disciplined borrowers who want to exploit the inherent wealth of a home. HELOC is the most flexible in how much you can borrow and when you can pay it back, compared to other home equity products. Their structures help you keep your monthly payments down and avoid unnecessary debt and interest.
However, HeLoc also has a fluctuating rate. This means you can pay more interest than you would negotiate. And the seemingly endless sense of credit lines can put them at risk for less disciplined borrowers.
When considering HELOC, be honest about the nature of your financial habits, potential risks, and the financing needs. HELOC works best when you need an indefinite total or if you need long-term funds. And the money should be spent improving your home and your financial profile.
HELOC FAQ
Additional Reports by Maya Dollarhide
