Pros and Cons of Home Equity Lines of Credit

A home equity line of credit (HELOC) can be a flexible way to tap into your home’s equity and withdraw cash to pay off high-interest debt, remodel your home, or meet other financial goals. Equity is the difference between what you owe on the home and its assessed fair-market value.

Home equity lines of credit can be attractive for people who need cash and have a decent amount of equity. But is there a catch?

Weigh the pros and cons of a home equity line of credit below to decide if it’s the best way to borrow. 

In this guide:

• What are the pros of a home equity line of credit?
• What are the cons of a home equity line of credit?

What are the pros of a home equity line of credit?

Home equity lines of credit can offer unique benefits to homeowners. A HELOC provides five potential benefits. 

Flexibility 

One of the highlights of a HELOC is flexibility. Unlike personal loans or home equity loans, a home equity line of credit lets you use as much or as little of your total credit as you want. Rather than a lump sum, you get access to an open line of credit, similar to a credit card. 

You only pay interest on the amount you use. If the lender approved you for a $130,000 HELOC but you only used $60,000, you’d pay interest on $60,000.

A HELOC might make sense if you’re still determining how much money you’ll need. For example, if you budget $30,000 for a kitchen renovation, you might take out a HELOC for $40,000 in case the project costs more than you anticipated. 

Use the funds as you wish

You might fund the following using a HELOC:

• Home improvements, repairs, and renovations
• New furniture
• Higher education or private school 
• A new-to-you vehicle
• Medical procedures or medical bills
• Emergency expenses, such as a sick pet or a vehicle breakdown

You could also use a home equity line of credit to consolidate other debts. For example, you might write a check from your credit line to pay off high-interest credit card balances. Whether that makes sense depends on whether your HELOC rate is lower than the APR on your credit cards. 

Low interest rates

Most HELOCs have variable, rather than fixed, interest rates. In this case, the rate is tied to a benchmark or index rate. When the benchmark rate is low, HELOC rates tend to follow.

On the other hand, the rate on a home equity or personal loan is fixed in most cases. If rates drop, you don’t benefit from interest savings. 

Remember that your rate on a home equity line of credit can depend on your creditworthiness. A higher credit score could help you qualify for lower rates. 

Tax-deductible

Under IRS rules, interest payments are tax-deductible only when you use a home equity line of credit to “buy, build, or substantially improve” the home that secures the loan. If you use your HELOC for home improvements or renovations, you might be able to write off the interest on your taxes. 

The IRS doesn’t specify what constitutes a qualifying expense, but you may be able to deduct HELOC interest to:

• Install solar panels or a whole-house generator
• Renovate your kitchen or bathroom 
• Build a deck or addition
• Repave sidewalks or driveways
• Rewire
• Replumb

Keep records of your spending if you plan to use a HELOC for home improvements. Save your receipts, and consult a tax professional before you file to make sure you can deduct the interest.

May have the option to lock in a fixed rate

While HELOC rates are often variable, some lenders may offer the option to lock in a fixed interest rate once repayment begins. For example, you might pay a variable rate for the first 12 months and then switch to a fixed rate. 

That option isn’t available in some cases and may incur additional fees. However, you might prefer to have it as a backup if you’re worried about rising interest rates. A fixed rate can also mean a fixed payment, allowing for more predictability and easier budgeting. 

What are the cons of a home equity line of credit?

Home equity lines of credit may not work for all homeowners. These six disadvantages might outweigh the benefits. 

Application process

Applying for a home equity line of credit is similar to applying for a mortgage.

In addition to the formal application and credit check, lenders require documentation verifying the applicant’s information, i.e., recent billing statements for all debt obligations, pay stubs, and W-2 forms.

Borrowing limits

The amount you can borrow with a HELOC depends on your home equity. Many lenders prefer to extend HELOCs to borrowers with a maximum combined loan-to-value (CLTV) of 80% to 85%. 

Combined LTV is the ratio of all the secured loans you have on your home (including your first mortgage and a HELOC) to the home’s value. A lower percentage is better—it means you have more equity in the house. 

For example, imagine your home is worth $200,000, and you owe $150,000 on the mortgage. An 85% loan-to-value ratio would mean you could have loans totaling $170,000 (85% of the home value). 

With that equity, you could get up to $20,000 in a home equity line of credit ($170,000 minus $150,000). A borrower with a lower CLTV may qualify for a larger loan. 

Variable interest rates

As we mentioned, HELOCs can have variable interest rates. That’s a benefit for borrowers when rates are low, but it can work against you if rates rise. 

Variable-rate HELOCs cap the maximum interest rate the loan can carry. Your rates can’t rise unchecked, but a higher rate can mean much higher payments. 

Since many home equity line of credit products have variable interest rates, it’s crucial to be aware that repayment amounts are not fixed. You may have a higher or lower payment at different points over the repayment term. Converting to a fixed rate would allow you to avoid that fluctuation. 

Fees and closing costs

In addition to interest, you might pay fees for a home equity line of credit. Standard costs include the following:

• Application fees
• Appraisal fees
• Annual maintenance fees
• Closing costs

Not all lenders charge these fees, and certain lenders will waive some or all of them. But knowing what costs you’ll pay upfront and on an ongoing basis to open and maintain a HELOC will prevent unwelcome surprises. 

Possible overspending

A home equity line of credit offers flexibility since you have an initial draw period in which you can spend your credit line. The typical draw period lasts 10 years, and you can choose to make interest-only payments during this time. 

But overusing your line of credit during the draw period could leave you with a large balance to pay down once the repayment period begins. Before taking out a HELOC, consider what you need the money for and how much of your credit line you anticipate using. 

Paying more than the minimum due during the draw period will help reduce the total amount you owe once repayment begins. 

Putting your home at risk

A home equity line of credit uses your home as collateral. If you default on a HELOC, the lender could initiate foreclosure proceedings against you. 

Because you could lose your home if you can’t pay, using home equity is much riskier than unsecured personal loans or other forms of debt. Borrowing an amount you’re confident you can repay will help you avoid a worst-case scenario with a home equity line of credit.

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If you’ve considered the pros and cons and think a HELOC might be right for your situation, check out our list of the best home equity line of credit rates and lenders.