Home equity lines of credit (HELOCs) are an option for homeowners looking to take advantage of their home’s equity. Unlike home equity loans with which you borrow a lump sum, HELOCs allow you to borrow in lesser amounts so that you’re only borrowing what you need when you need it. Borrowing only what you need can keep your monthly payments lower and help you avoid unnecessary debt. At the same time, these variable payment amounts could be a risk for less disciplined borrowers.

What is a home equity line of credit (HELOC)?

A home equity line of credit (HELOC) offers a line of credit you can borrow against when you need to. Like credit cards, HELOCs come with variable interest rates, and for a period of time, your monthly payment will vary depending on your current interest rate and how much you borrow at any given time.

With a HELOC, you are typically given a maximum amount that you can borrow based on equity you have in your home. You can choose to use some or all of your line, and you are charged interest based on only the amount that you’ve actually borrowed. So if you haven’t used any of your line of credit, you won’t owe any principal or interest.

Pros of a home equity line of credit

With a HELOC, you can typically borrow up to 85 percent of your home’s value, minus outstanding mortgage payments, which means that these loans won’t work for borrowers who don’t have considerable equity. You also need good credit to qualify, as well as provable income to repay your loan. If you’re a candidate for a HELOC, here are some of the biggest advantages.

You could qualify for a low APR

While mortgage interest rates overall have risen this year, HELOCs still tend to have lower interest rates and lower initial costs than credit cards, which makes them attractive for debt consolidation or ongoing projects.

Interest might be tax-deductible

Even after the Tax Cuts and Jobs Act of 2017, you can still deduct interest paid on a home equity line of credit (or home equity loan) if you use the money for home improvements. Specifically, the IRS says that interest payments on home equity products are deductible if they are used to “buy, build or substantially improve the taxpayer’s home that secures the loan.” You can only take the deduction up to a certain threshold, however, based on the combined interest of the first and second mortgage.

You can borrow only what you need

Another advantage of HELOCs is that you can use funds as you need them. Where home equity loans and even personal loans require you to take out a lump sum, you can use a HELOC in bursts if you want, only borrowing the cash you’ll use as you go along. If you wind up needing less cash than you thought, you’ll have a smaller monthly payment.

Flexible repayment options

HELOCs often provide flexibility in terms of how you pay them off. The timeline for your HELOC can vary depending on how much you want to borrow and the lender you go with, but HELOCs can last for up to 30 years. You’ll typically have to make only interest payments during the draw period, or the initial 10 years, but you have the option to make principal payments as well to lower the balance remaining when you enter the repayment period.

Some HELOC lenders have also begun offering fixed-rate options, which let you lock in a portion of your HELOC balance at a fixed interest rate for a period of time.

Potential to raise your credit score

Two of the most important components of your credit score are your payment history and the different types of credit you have. Adding a HELOC to your credit portfolio and making on-time and regular monthly payments can boost your credit score since it shows a streak of good financial habits.

Few restrictions on how you use the funds

With a HELOC, there are very few restrictions on how you can use the funds. Although your HELOC is secured by your home, you don’t have to use the funds from a HELOC on home improvements. You can use the money for higher education expenses, travel or debt consolidation, for example.

Cons of a home equity line of credit

Being able to tap your home’s equity is a good option to have, but HELOCs do have some disadvantages. Consider these drawbacks before you move forward with this loan option.

Home as collateral

A HELOC is a secured loan, meaning you put your home up as collateral for the loan. While having a secured loan can help you obtain a lower interest rate, you’re taking on some additional risk.

“Because you are borrowing against your home, if you can’t make your monthly payments, you risk foreclosure,” says Sean Murphy, assistant vice president of Equity Lending at Navy Federal Credit Union.

Variable interest rate

Where home equity loans offer a fixed interest rate that will never change, home equity lines of credit come with variable rates. This means that your rate can go up or down based on the decisions of the Federal Reserve — so even if you take out a HELOC with a low rate, you could face high rates when it comes time to pay. This is especially true in 2022, as the Federal Reserve continues to hike its key rate.

Overspending risk

One disadvantage of HELOCs often stems from a borrower’s lack of discipline. Because HELOCs allow you to make interest-only payments during the draw period, it is easy to access cash impulsively without considering the potential financial ramifications.

“If the borrower is not returning funds to this line of credit, then the loan eventually begins to amortize and the payments go up significantly,” says Joseph Polakovic, owner and CEO of Castle West Financial in San Diego.

If you’re not expecting or accounting for the increase in monthly payments at the end of the draw period, it can be an unwelcome surprise.

You’re reducing the equity you have in your home

When you borrow through a HELOC, you’re borrowing against home equity you worked hard to build up. If housing prices drop, you could wind up owing more than your home is worth. Having an outstanding HELOC also limits your additional opportunities to borrow from your equity.

Alternatives to a home equity line of credit

HELOCs can be extremely useful, but they’re not exactly perfect — at least not for everyone. Here are some loan alternatives to consider in place of a HELOC.

  • Home equity loan – A home equity loan is very similar to a HELOC, but instead of a credit line, it gives you a lump sum of cash. You’ll have a set repayment period and a fixed interest rate, meaning your monthly payment will never change. Murphy says that if you’re looking to spend as you go — and only pay for what you’ve borrowed, when you’ve borrowed it — a HELOC is probably a better option. If you know exactly how much you need upfront, a home equity loan could be a better option than a HELOC.
  • Cash-out refinance – A cash-out refinance replaces your existing mortgage with a new loan with a higher balance. Many lenders will let you refinance and borrow up to 80 percent of your home’s value, with you receiving the difference in cash. If your home is worth $400,000 and you owe $200,000, for example, you could potentially do a cash-out refinance with a new loan for $320,000 and get $120,000 in cash, minus closing costs.
  • Personal loan – Like home equity loans, personal loans come with a fixed monthly payment, a fixed interest rate and a lump sum of money upfront. The big difference between personal loans and home equity loans and HELOCs is that personal loans are unsecured, so you don’t have to put your home up as collateral. Personal loans can also be easier to apply for because you can often fill out an application online and you don’t have to prove how much your home is worth. They do tend to come with higher interest rates than home equity products, however.

Bottom line

Home equity lines of credit (HELOCs) are an option for disciplined borrowers who want to take advantage of their home’s equity. HELOCs have the most flexibility in terms of what you can borrow and when you can pay it off. However, HELOCs also come with risks. You must put your home up as collateral and interest rates are variable. When considering a HELOC, think honestly about your financial habits, the potential risks and whether or not this product is the best fit for your needs.