Pros and cons of a home equity line of credit (HELOC)

A home equity line of credit, or HELOC, lets you borrow against your home equity much like a credit card: draw what you need, when you need it, and pay interest only on what you’ve used. For the right expense, it’s the cheapest large-dollar borrowing option most homeowners can get.

But HELOCs also carry risks you won’t find with credit cards. Your house is the collateral, so if you fall behind on payments, you could lose your home to foreclosure.

If you’re facing a cost that will arrive in pieces over months or years, like a phased renovation, tuition bills or a course of medical treatment, a HELOC could be the right tool. If you know the exact amount you need and you need it in a lump sum, or if a variable payment would break your budget, a fixed-rate home equity loan does the same job without the risk of a future payment increase.

Pros and cons of a HELOC

An important requirement for a HELOC is having enough equity in your home. Most lenders want you to keep at least 20% of your home’s value as your own stake after borrowing (even when factoring in your mortgage), though lenders may qualify you with as little as 5%.

You’ll also need a credit score in the mid-600s, with 620 being the common floor for HELOCs and 740 or above getting you the best rates, plus a debt-to-income ratio of 36% or less. Some lenders stretch to 43% or even 50%. Lenders will also want proof of stable income and a record of on-time mortgage payments.

Advantages of a HELOC

• Lower interest rates than unsecured debt: HELOC rates are well below those on credit cards or personal loans, because your home secures the debt. On a five-figure renovation or a debt consolidation, that difference can be worth thousands of dollars.
• Flexibility to borrow as needed: If you aren’t sure exactly how much money you’ll need, a HELOC lets you borrow on demand, up to your credit limit. This also means that during the draw period, you only pay interest on what you’ve borrowed, not the full credit line.
• High loan limits: HELOCs offer access to large sums, at least five figures. And if you want to unlock more of your home equity, a HELOC may let you tap more than a home equity loan. With a HELOC, you can generally borrow up to 80% of your equity stake, though some lenders go as high as 95%. How much equity you can tap with a HELOC depends on your home equity and finances.
• Potential tax benefits: If you plan to use the funds to renovate your home, you might be able to deduct the interest paid on your HELOC on your federal income taxes. Specifically, the IRS allows deductions on the interest if the funds are used to “buy, build, or substantially improve the residence.” The deduction covers your mortgage and HELOC balances combined, up to $750,000, or $375,000 if you’re married filing separately. You also have to itemize, which only pays off if your itemized deductions beat the standard deduction. Speak to a tax professional before banking on this deduction.

Because you’re only charged interest on what you draw, some homeowners open a HELOC and leave it sitting at zero as a sort of emergency fund. “You can get a HELOC, put a zero balance on it and have it sit there,” says Bill Lyons, president and CEO of Griffin Funding.

That works only if your lender doesn’t charge you for the privilege. Many HELOCs carry an annual fee, some add an inactivity fee if you don’t make withdrawals and a few require a minimum draw at closing, which starts the interest clock immediately. Check all three before you treat a HELOC as a standby fund.

Disadvantages of a HELOC

• Rates are variable: If a rising payment would strain your budget, this drawback should be the deciding factor. A home equity loan carries a fixed rate for the life of the loan, but a HELOC rate moves with economic conditions, the Fed’s monetary policy and other factors. When market rates rise, your rate and your payment rise with them, and you have no say in the timing.
• Your house is on the line: A HELOC is a secured form of debt, which means your home serves as collateral for the credit line. If you miss payments, you risk foreclosure. Unsecured borrowing options like a personal loan or credit card don’t carry this same risk, but rates are significantly higher as a result.
• Reduced equity cushion: When you borrow a HELOC, you’re borrowing against your home’s equity. If home prices and property values drop, you could wind up owing more than your home is worth. (This is true of any type of home equity borrowing, including home equity loans.)
• Potential to run up a balance quickly: If you aren’t disciplined, a HELOC’s credit line could lead you to take on more debt than you can afford.  Because many HELOCs allow interest-only payments and let you borrow up to the full credit line during the draw period, it’s easy to access cash without considering the financial ramifications. An unwelcome surprise can await you when the repayment period starts if you haven’t budgeted for the substantial jump in your monthly payments. 

Is a HELOC a good idea?

Whether a HELOC is the right borrowing option for you depends on a few things:

• How will you use the funds? If the expense comes in stages and you can’t pin down the expected total — like a multi-phase home renovation, tuition bills over four years of school, or an open-ended course of medical treatment — a HELOC is the right structure because you only pay for what you use. If you know the exact number today, a fixed-rate home equity loan provides more predictability.
• Can you afford the repayment-period payment on the full line? Imagine the repayment period has begun and you’ve maxed out the credit line. And since rates can rise with the market, consider what your monthly payment could be at the maximum allowable rate for your line. If that payment fits alongside your mortgage, taxes and insurance, with three to six months of expenses still in savings, you have the cushion this product requires. If it only works at the interest-only payment, the line is too big. Ask the lender for a smaller one.
• How much equity would you have left? If you’d still have 20% or more of your home’s value after borrowing, you have room to absorb a price decline or sell if you need to. If you’d drop below 15%, a modest dip in local values can leave you underwater with no way out that doesn’t involve writing a check at closing.
• How long will you carry the balance? If you’ll be repaying for years, the HELOC’s lower rate more than covers its fees. If you expect to only need the line for 18 to 24 months, price a 0% intro APR card or a personal loan first. Paying closing costs plus an annual fee to borrow short-term is a steep premium, and neither of the unsecured alternatives puts your house at risk.

What happens to your payment when the draw period ends

The repayment period is where a HELOC gets expensive, and most borrowers never budget for it.

During the draw period, typically 10 years and sometimes as short as five, many lenders let you pay interest only. Nothing you pay goes toward principal, so the balance doesn’t move. When the repayment period starts, you can no longer draw, and your payment switches to principal plus interest on the full balance.

Here’s what that looks like on a $50,000 balance:

The shift from interest-only to full repayment adds more than the rate move does, and a short repayment period almost doubles the payment even without a rate hike. Both can hit in the same month.

This is why it’s so critical to budget for the most expensive scenario. You can also pay down the principal during the draw period, even when the lender doesn’t require it, which costs nothing extra and helps you get ahead on repayment.

HELOC vs. home equity loan: Which is right for you?

Both home equity loans and HELOCs borrow against the equity you’ve built in your home. Both require approximately 15% to 20% stake remaining after borrowing, and both put your house up as collateral. But they differ in some substantial ways that make one a better option than the other, depending on your needs.

A home equity loan provides a lump sum at a fixed rate, and repayment starts right away. Your payment stays the same over the full loan term. On the other hand, a HELOC gives you access to a credit line you can draw from as needed for an initial 5- to 10-year term. During that introductory period, you’ll typically only pay interest (not principal) on what you’ve borrowed. And unlike home equity loans, HELOC rates move up and down with the market, making it tricky to budget for repayment.

If you know the exact amount and you need it now, like a $40,000 roof replacement, take the home equity loan. You’ll pay interest on the full sum from day one, but you’ll know your payment for the life of the loan and a rate increase can’t reach you. If the cost will arrive in pieces and you can’t pin down the total, take the HELOC. Paying interest on the $15,000 you’ve actually drawn beats paying it on a $60,000 lump sum sitting unused in your checking account.

If you’re on the fence, consider the fees associated. A HELOC usually costs less to open, because it skips charges like title insurance that a home equity loan often carries, but it adds annual and inactivity fees a loan doesn’t have. A line you barely touch can cost more than a loan you steadily pay down. Weigh the annual fee against what you actually expect to borrow before you open it.

Alternatives to a HELOC

If neither a HELOC nor a home equity loan fits, here are some alternatives to consider:

• Cash-out refinance: A cash-out refinance replaces your existing mortgage with a bigger loan and hands you the difference in cash. Since this loan type reprices your entire mortgage balance at the new rate, not just the cash you take out, it can cost far more over time if you move to a higher rate. You’ll also pay closing costs on the full loan amount rather than on the portion you’re borrowing. A cash-out refi makes sense if you can get a lower rate than you have now, you can afford the closing costs and you plan to stay in the home long enough to earn them back. If you’re holding a low rate, a HELOC or home equity loan is the less expensive option.
• 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 these loans and HELOCs is that personal loans are unsecured, so you don’t have to put your home or any other asset up as collateral. The catch is that they tend to come with higher interest rates than HELOCs, and you may not be able to borrow as much.
• 0% intro APR credit card: If you can pay off your full balance within the promotional window, a 0% intro APR card beats every option on this page on cost. Promotional periods often run six to 21 months. By paying the balance off before the window closes, you’ll owe no interest at all. But if you still have a balance at the end of the introductory period, the regular rate applies to what’s left, which is usually well into the double digits. Like a personal loan, this option doesn’t require your home as collateral.

Next steps 

Before opening a HELOC, take stock of your home equity, credit score, income and existing debt to get an idea of what you might qualify for. Compare offers from several HELOC lenders, paying attention to the rates, closing costs, draw and repayment periods and other terms. Use a HELOC payoff calculator to estimate how much your monthly payments will be and how rising rates at the end of the draw period may affect your budget. 

Most importantly, remember that a HELOC uses your home as collateral, and rates are adjustable. Before signing, make sure you can comfortably afford payments, even if rates were to rise.

Frequently asked questions

• How does HELOC repayment work?

  A HELOC has two distinct stages: a draw period and a repayment period. The draw period is the first stage, usually lasting 5 to 10 years, when you borrow funds as needed. During this time, you might only be required to make monthly interest payments. Once the draw period ends, you’ll enter the repayment phase, which can last up to 20 years. During this time, you’ll make monthly payments that include the sums you borrowed, plus interest. Most HELOCs amortize these payments, so you’ll have repaid your debt in full by the end of the repayment period. However, some HELOCs come with a balloon payment: They demand full reimbursement at the end of the draw period.

• What is a fixed-rate HELOC, and how does it differ from a traditional HELOC?

  A traditional HELOC has a variable interest rate, so your rate and minimum payments can fluctuate.

  In contrast, a fixed-rate HELOC is much like a home equity loan: It lets you bypass the uncertainties of fluctuating interest rates in favor of a predictable payment in the same amount each month. Typically, you take out a traditional HELOC, then — after you first withdraw funds — you freeze a portion or all of your balance at a fixed interest rate, protecting you against market fluctuations. Lenders often let you “lock in” a rate several times during the draw period. They may charge a small fee each time.

  A fixed-rate HELOC can be especially appealing when rates are low or are expected to rise.

• Is a HELOC right for me?

  Whether a HELOC is right for you depends on whether you value flexibility and lower initial costs over long-term payment stability. If you’re a homeowner with at least 20% equity (some lenders accept less) and a credit score above 620, a HELOC offers a revolving line of credit that lets you borrow only what you need and pay interest only on that amount — making it ideal for ongoing expenses like phased home renovations. But because HELOCs typically have variable interest rates, your monthly payments could rise unexpectedly, and because the loan is secured by your property, failure to repay puts your home at risk. If you prefer predictable, fixed monthly payments or are funding a one-time expense with a known cost, a traditional home equity loan might be the safer, more appropriate choice.

• Can opening a HELOC boost your credit?

  Yes, a HELOC can boost your credit score by adding to your credit mix if you make payments on time. But don’t be surprised if your score dips slightly after applying, since the lender typically runs a hard credit check. Also keep in mind that a HELOC could lower the average age of your credit accounts and increase your overall debt load, which could also lower your score.