The 10 Pros and Cons of Home Equity Lines of Credit

Home equity lines of credit (HELOCs) allow you to access the equity in your home. It’s similar to a credit card—you can spend up to the credit limit, and you’re only responsible for repaying the amount you use. 

HELOCs provide flexibility, tax deductions, low interest rates, and high borrowing limits, benefiting homeowners. However, the cost of a HELOC can add up due to variable interest rates and loan fees. Whether or not a HELOC is the right fit depends on your finances and goals. Here’s what to consider. 

HELOC pros 

Home equity lines of credit provide numerous benefits for homeowners, including flexibility and low interest rates. Here’s how you can benefit from accessing your equity with a HELOC. 

Flexible access to funds

Compared to other borrowing options, HELOCs offer extra flexibility in how you borrow and repay the funds. Because it’s a line of credit, you can spend as much or as little as you want, up to the limit. You’re only responsible for paying back what you spend, and the amount that’s due varies depending on your phase. 

HELOCs have two phases: the draw period and the repayment period. During the draw period, you can spend the money and borrow from the line of credit. Most HELOCs have draw periods that range from two to 10 years. Even though you have to make interest-only payments throughout the draw period, total payments aren’t due until the repayment period begins.

Potential tax deductibility

Home equity loans are tax-deductible. You can deduct interest paid on home equity loans if you use the funds to “buy, build, or substantially improve” your home. You can’t take advantage of tax deductions if you use the money for other expenses like medical bills, travel, or debt consolidation. However, you can utilize the tax advantage by spending money on home renovations. 

The tax deduction is a valuable perk that can help you save money during tax season. It also reduces the cost of borrowing money—the more you can deduct, the less the loan costs. 

Lower interest rates

HELOCs usually have lower interest rates than unsecured loans like personal loans and credit cards. You can get a lower interest rate with a HELOC because it’s a secured loan, and your house is the collateral for the lender.  

The interest rate determines the cost of the loan, and higher rates mean that the loan costs more. For example, if you borrow $30,000 with an 8% interest rate and a 10-year repayment term, the total cost of the loan is $43,677.93. But if you borrow the same amount with a 6% interest rate, the total cost decreases to $39,967.38. 

Interest-only payment option

HELOCs have a unique repayment structure that you can’t find with other types of loans. Repayment has two phases: the draw period and the repayment period. You can spend the line of credit during the repayment period, but you don’t have to make full payments yet. Instead, you’re only responsible for interest-only payments.

Interest-only payments are much smaller than payments due during the repayment period. You still owe the money and have to repay what you borrowed, but you have more time to repay it. The additional time can make repayment less stressful. 

Large borrowing capacity

The borrowing limit for a HELOC is higher than that of other types of loans. You can typically borrow up to 85% of your home’s value minus what you owe on your mortgage. The higher-than-average borrowing limit means you have more flexibility to fund large expenses.

The biggest perk of a higher limit is that you don’t have to use different types of loans or multiple credit cards to pay for what you need. Instead, you can simplify the process and use a HELOC to pay for everything.

No restrictions on use

You can use a HELOC to pay for almost any expense. It’s one of the most flexible funding options, and you can also use the money for different expenses. For example, let’s say you have a $100,000 HELOC. You decide to use $75,000 for home renovations and the remaining $25,000 for medical expenses. You don’t need to get permission to use the funds. 

You can use a HELOC to pay for nearly anything, including the following expenses. 

• Home renovations
• Pay off student loans
• College fees
• Unexpected bills
• Assisted living facilities
• Debt consolidation
• Medical expenses
• Business expenses
• Wedding costs

HELOC cons

Even though a HELOC can be an excellent choice for some borrowers, it’s not the right loan for everyone. Here are the potential drawbacks when deciding whether a HELOC is the best option.

Risk of foreclosure

HELOCS are secured loans. You provide collateral to the lender, and in exchange, the lender usually offers you a lower interest rate than you could get with an unsecured loan. 

With a HELOC, your home is the collateral. If you default on the loan, your lender can foreclose on your home. Even if it’s unlikely that you’ll fall behind on payments, it’s still an important consideration. Your home is probably your biggest asset, so it can be risky to use it as collateral. It’s also the place you live, so it can be extra distressing if there’s a chance of foreclosure. 

Variable interest rates

HELOC interest rates are usually variable and can change throughout the repayment term. When your interest rate changes, your payment also changes. Some HELOCs have fixed rates, but it’s more rare.

Variable interest rates can increase or decrease. If the rate decreases, your monthly payment becomes smaller. But if it increases, your payment becomes larger. Variable interest rates can make planning harder, especially if you’re on a tight budget or have limited income. 

Closing costs and fees

Most HELOC lenders charge closing costs and other fees. These fees can increase the total cost of borrowing money and, in some cases, make it more expensive than other loan options. The total cost is usually between 2% and 5% of the loan amount. 

Here are the most common closing costs that HELOC lenders charge.

• Origination fee
• Appraisal fee
• Credit check
• Title search
• Preparation fee
• Recording fee

Potential for overborrowing

HELOCS have higher-than-average total loan amounts. The equity in your home determines how much you can borrow. Most lenders allow you to borrow up to 85% of the equity in your home minus the amount you owe on your mortgage. Even though a higher borrowing limit can be helpful, it can also increase the risk of overborrowing. 

When you overborrow, you owe more than you can comfortably repay. If that happens, paying necessary expenses like your mortgage or utilities bills in addition to your HELOC payment might become difficult. Overborrowing can lead to increased stress, lower credit scores, and, in some cases, loan default. 

The ideal candidate for a HELOC is best for someone who has a higher-than-average credit score, a low debt-to-income ratio, and who has paid off the majority of their mortgage. 

I emphasize a low debt-to-income ratio because if or when interest rates adjust, you have to be flexible enough to have room in your budget to afford a higher payment and not risk losing your home. 

HELOCs give these borrowers the advantage of borrowing a large amount without being obligated to spend it within a certain category but rather on anything they choose.

Crystal Rau, CFP®

Takeaway: HELOCs are a flexible option for disciplined borrowers 

HELOCs are a solid option for disciplined borrowers who want maximum flexibility. As long as you can avoid overborrowing, minimize fees, budget for changing interest rates, and always pay on time, the benefits of a HELOC outweigh the drawbacks. 

Borrowers with home equity can take advantage of tax deductions, low interest rates, flexible repayment, and large loan amounts. The best part? You can use the funds for nearly any expense. 

Whether you’re preparing for a home renovation or paying for a wedding, responsible borrowers can use a HELOC to borrow money at a lower interest rate. 

Pros

• Flexible access to funds for ongoing or recurring expenses

• Potential tax deductibility if used for home improvements

• Lower interest rates compared to unsecured credit options

• Interest-only payment option during the draw period

• Large borrowing capacity based on home equity

• No restrictions on how funds can be used

Cons

• Risk of foreclosure if unable to repay

• Variable interest rates that may increase over time

• Potential for overborrowing due to easy access

• Accumulated fees