HELOC Pros and Cons

The Benefits and Drawbacks of Tapping Home Equity With a HELOC

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A home equity line of credit (HELOC) lets you turn your home into a source of cash. Much like a credit card, you can take cash from the HELOC when you need it and only pay interest based on the money you borrow.

HELOCs can be useful for many different purposes, but it’s important you understand the pros and cons of a HELOC before you commit.

Key Takeaways

  • HELOCs let you turn your home equity into a source of cash, allowing you to borrow money as you need it and only pay interest on that amount.
  • Some HELOCs have ongoing maintenance fees.
  • HELOCs use your home as collateral, adding risk.

Pros and Cons of HELOCs

Pros
  • Low interest rates

  • Access to money when you need it

  • Only pay interest on what you borrow

  • Can be easier to qualify for than other loans

Cons
  • Variable rates mean your costs could rise

  • Upfront and ongoing fees

  • Your home serves as collateral for the loan

  • You must have sufficient equity

Pros Explained

  • Low interest rates: Because they’re secured by the value of your home, HELOCs tend to have much lower interest rates than other kinds of loans, often making it an affordable borrowing option. 
  • Get money when you need it: Unlike other loans that offer a one-time payout, you can withdraw funds from a HELOC multiple times as the need arises, so long as you’re within the draw period.
  • Only pay interest on what you borrow: Like a credit card, you only pay interest on your outstanding balance. If you don’t draw the full amount from the HELOC, you won’t owe interest.
  • Can be easier to qualify for than other loans: Because you have an asset securing the loan, some lenders may be willing to approve the loan even if you have less than perfect credit.

Cons Explained

  • Variable rates mean your costs could rise: Many HELOCs come with variable interest rates, meaning that, unlike a fixed rate, they can change. If rates rise, you could find your payments increasing.
  • Upfront and ongoing fees: Many lenders charge an origination or similar fee when you set up a HELOC. They may also usually charge maintenance fees to keep the line active.
  • Your home serves as collateral for the loan. If you fail to make payments on your HELOC, the lender could foreclose on your home, adding significant risk to borrowing.
  • You must have sufficient equity: The amount you can borrow depends on the equity you’ve built in your home. If you have limited equity, your ability to borrow will be limited.

HELOC vs. Home Equity Loan

HELOC Home Equity Loan
Secured by your home equity Secured by your home equity
Low interest rates Low interest rates
Usually variable rate Variable or fixed rate
Draw funds multiple times One-time payout
Upfront and annual fees Upfront fees, but no annual fees

Secured by Home Equity

Both home equity loans and HELOCs are secured by the value of your home. The amount of equity that you have directly impacts the amount that you can borrow. More equity means a higher borrowing limit.

Using your home to secure either a home equity loan or a HELOC loan means you’re putting your home at risk. If you fail to make payments, the lender can foreclose.

Interest Rates

An advantage to securing a home equity loans and a HELOCs with your home is that it greatly reduces the lender’s risk. That means these loans have some of the lowest rates of any type of debt.

One important difference between the two is that HELOCs tend to have variable interest rates. That means the rate can change over time based on market rates. With a home equity loan, you usually have the choice of variable or fixed rates.

Access to Funds

An important difference between HELOCs and home equity loans is when you can access funds.

HELOCs let you draw funds multiple times as the need arises. That makes them ideal for people who might need cash quickly or who need to withdraw cash multiple times.

Home equity loans give a one-time distribution of cash, which makes them better for one-time expenses such as paying for a home renovation.

Fees

Both HELOCs and home equity loans include fees. Both loans usually carry origination fees and closing costs that you pay upfront. However, only HELOCs have annual maintenance fees that lenders charge to keep the line of credit open. Home equity loans don’t tend to have ongoing fees to pay.

How To Get a HELOC

If you think that a HELOC is right for you, here’s how you can find one.

Compare Lenders

The first thing to do when you’re looking for any type of loan is shop around and compare different lenders. Every lender will offer different rates, fees, and other features for their loans. If you take the time to look at a few different options, you might find one that’s offering a much better deal.

Gather Your Information

Before applying, make sure you have all the necessary documents ready. You’ll need things like:

  • Personal identification, including Social Security number
  • Income information and employment history 
  • Home documents, including a recent mortgage statement
  • Proof of homeowners’ insurance
  • Property tax bills
  • Information about other outstanding debts
  • A list of your assets and account statements

Before you apply for a HELOC, take some time to check your credit and make sure that everything looks accurate.

Submit an Application

Once you’re ready, you can submit an application for a HELOC. Provide all the requested documents and work with your lender to verify the details of your home value, employment and income history, and answer any other questions they might have.

Appraisal

If your lender approves you for a HELOC, they’ll want to confirm that your home is worth enough to properly secure the loan. They’ll order an appraisal of your home to determine its value. The result of this appraisal can play a role in determining how much you can borrow with your HELOC.

Closing

If the appraisal comes back and shows you have sufficient equity, the next step is closing. You’ll sign all of the loan documents and paperwork. You will have three days to cancel the HELOC if you change your mind.

Use Your Line of Credit

After the three-day waiting period, your HELOC is officially open and you can start accessing the line of credit. You will have a draw period—typically 10 years—from which to access the funds as needed. During this time, you will start making monthly payments to include a portion of the principal (the amount you borrow) plus accrued interest.

Alternatives to HELOCs

HELOCs are one option for homeowners looking to get cash out of their homes, but there are alternatives to consider.

Home Equity Loan

A home equity loan provides a one-time distribution of funds that homeowners can use for things like paying a large medical bill, funding home improvement, or consolidating debt. 

Home equity loans are typically fixed-rate loans and are ideal for one-time expenses. They’re not the best choice for situations where you might need to withdraw funds multiple times.

Cash-Out Refinance

A cash-out refinance lets you refinance your entire mortgage and take some of the equity out of your home as cash. For example, if you owe $200,000 on your mortgage and have a home worth $300,000, you could refinance your mortgage with a new, $250,000 loan to replace the existing loan and get $50,000 in cash.

Like home equity loans, cash-out refinances are best for one-time expenses because they offer a one-time payout of funds. However, because they replace your entire mortgage, they tend to be most useful when you can refinance to a lower rate or want to trade an adjustable-rate mortgage for a fixed-rate one.

Reverse Mortgage

A reverse mortgage lets homeowners age 62 or older turn their home equity into a source of income during retirement. These loans are far more complex than HELOCs and other equity-based loans, so it’s important to do your due diligence before getting one.

In general, they can be a good choice for older homeowners who need to supplement their income but aren’t useful for many other situations.

Frequently Asked Questions (FAQs)

How much money can I get with a HELOC?

The amount of money you can get with a HELOC depends on your home equity. Some banks allow you to get a HELOC of up to 90% of your home’s value.

For example, if you have a home worth $100,000 and still owe $50,000 on the mortgage, you could get at most $40,000 from a HELOC because you must maintain 10% equity.

How do you calculate the payment you need to make on a HELOC?

Because a HELOC works much like a credit card, you can calculate the payment in much the same way you determine your credit card payment. Your lender is required to disclose the payment terms so you fully understand how your HELOC repayment will work before you agree to the loan.

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Article Sources

  1. Consumer Financial Protection Bureau. “What You Should Know About Home Equity Lines of Credit,” Page 8. 

  2. Consumer Financial Protection Bureau. “What You Should Know About Home Equity Lines of Credit,” Page 7. 

  3. Discover. “Differences Between a Home Equity Loan and Home Equity Line of Credit.”

  4. Santander Bank. “9 Steps of the HELOC Application Process.”

  5. Consumer Financial Protection Bureau. “What You Should Know About Home Equity Lines of Credit,” Page 6.

  6. Alliant. “Home Equity Line of Credit.”

  7. Federal Trade Commission. “Home Equity Loans and Home Equity Lines of Credit.”