HELOCs offer a flexible way to tap into your home equity and get the cash you need. They come with several perks that make them worth considering, but there are also potential downsides to keep in mind before applying. Read on for a closer look at the pros and cons of HELOCs in 2024 and how to decide if they make sense for your financial situation.
What is a HELOC, and How Does It Work?
As the name suggests, a home equity line of credit (HELOC) is a revolving line based on the amount of equity you have in your home. More specifically, it lets you borrow against the amount of your home you own outright, which is the difference between the current property value and the outstanding mortgage balance.
Like a credit card, a HELOC lets you borrow up to a preset amount – typically no more than 85% of your home equity. For example, if your home is worth $469,000 and you owe $319,000 on your mortgage, the lender may approve you for a HELOC of up to $79,650 ($469,000 * .85 – $319,000).
If approved, you get access to the pool of funds and can pull cash during what’s referred to as the draw period. It typically lasts 5 to 10 years, and you’ll generally make interest-only payments during this period. Keep in mind that interest rates are variable, so borrowing costs and monthly payments will fluctuate over time.
When it ends, the repayment period of 10 to 20 years commences. The amount you’ll pay monthly also increases since a portion of the principal is added.
The Pros of HELOCs
Here’s a closer look at the key benefits you can access by taking out a HELOC.
Flexible Access to Funds
With a HELOC, you have the luxury of pulling from a pool of cash as needed. You also control the borrowing costs since interest must only be paid on the amount you borrow. You won’t get the same benefit with an installment loan that comes in a lump sum with built-in interest on the amount you borrow.
Potential Tax Benefits
The interest you pay on a HELOC could be deductible at tax time if the funds are used to perform certain home improvements. Be sure to consult with a tax advisor to learn more about this benefit and to determine what’s needed to qualify.
Interest Rates and Payment Terms
HELOCs generally come with lower interest rates than credit cards and unsecured personal loans, making them a more attractive option. This is due to their secure nature, which gives lenders recourse if you default on the loan payments.
Regarding payments, you’ll only pay interest in most cases during the draw period. The monthly payments won’t include interest until after it ends, which could be between five to 10 years.
Use for Home Improvements
Homeowners commonly use HELOCs to fund home improvements, and for good reasons. The benefits are twofold: You’ll improve the livability of your home and, with the right renovations or upgrades, could substantially increase its value.
Revolving Credit
A HELOC functions as a revolving line of credit, similar to a credit card. This means you can borrow, repay, and borrow again up to your credit limit during the draw period. A revolving credit is quite useful if you need to cover ongoing expenses, like those associated with costly home renovations or other projects.
The Cons of HELOCs
There are also potential downsides to consider before making a decision.
Variable Interest Rates
The variable interest rate associated with HELOCs means your monthly payments will be unpredictable. Since interest rates cannot be predicted, you’ll need to be prepared for constant fluctuations as market conditions change.
Risk of Foreclosure
HELOCs are secured debt products that use your home as collateral. So, defaulting on the loan agreement or missing loan payments could cause you to lose your home to foreclosure.
Potential Fees and Costs
To secure a HELOC, you’ll likely pay closing costs between 2% and 5% of the amount you borrow. But those may not be the only expenses you’ll incur. Some lenders also assess maintenance fees on HELOCs while they’re open, and you could incur an early repayment penalty if you decide to close the line prematurely.
Impact on Credit Score
Opening a HELOC can impact your credit score in several ways. For starters, the lender will perform a hard inquiry, which may temporarily lower your score by a few points. If you carry large balances on your HELOC, your credit utilization ratio will increase, which can also hurt your score. As previously mentioned, late or skipped payments can further affect your credit rating.
Temptation to Overspend
If you get access to a rather hefty credit limit, it can be tempting to pull out more funds than you actually need. Unfortunately, this can lead to overspending and a debt load with payments that are difficult to manage.
When a HELOC Makes Sense
A HELOC could be a smart financial move in these situations:
For Home Renovations
Making the right home renovations could increase your property’s value, which means greater earning potential if you decide to sell your home. Funding time-intensive renovation projects using a HELOC is also easier, as you can borrow as needed and control interest costs.
For Debt Consolidation
You can also use a HELOC to consolidate high-interest debts. Doing so can potentially save you a bundle in interest and make it easier to manage your debt load, as you’ll have a single monthly debt payment instead of several. Keep in mind that you are using your home as collateral, so timely payments are a must to avoid losing your property to foreclosure.
For Major Life Expenses
Using a HELOC to fund big-ticket purchases, cover unexpected expenses or meet financial goals could also be ideal. Or you can tap into your home equity to create an emergency fund that gives you peace of mind if life happens.
When to Avoid a HELOC
You may want to steer clear of a HELOC if any of the following apply:
Unstable Financial Situation
When your income is unpredictable, or you are facing job insecurity, taking on additional debt can increase stress. If you can relate or if your financial situation is shaky, be sure to avoid a HELOC, as it’s risky to commit to monthly debt payments if your income is unstable.
Remember, missing payments on a HELOC can lower your credit score if the loan becomes delinquent for 30 days or more. You could face foreclosure if you skip several payments since your home is used as collateral to secure the HELOC. This may lead to foreclosure since your home is used as collateral.
For Non-Essential Expenses
Using a HELOC for non-essential costs, like vacations or luxury items, can lead to long-term financial problems. Since HELOCs use your home as security, you’re risking your most important asset for short-term pleasures.
You’re better off saving for non-essential expenses or using other forms of credit that don’t jeopardize your home in the event you experience financial hardship.
High Interest Rate Environment
When interest rates are high, it’s best to steer clear of HELOCs. While they often feature lower initial rates compared to other loan products, you’ll still deal with variable rates. This could mean relatively steep monthly payments and borrowing costs if interest rates rise. In this scenario, a cash-out refinance or traditional loan could be a more cost-effective alternative.
Conclusion: Should You Get a HELOC in 2024?
If you have a large amount of home equity, a HELOC could make sense. Consider the pros and cons they offer, run the numbers and explore alternatives to make the right choice.
If you decide to proceed with a HELOC, be sure the rate you receive is lower than that of other debt products you’ve considered. Also, only borrow what you need to keep your borrowing costs in check.
Frequently Asked Questions About HELOC Pros and Cons
Getting a HELOC in 2024 isn’t impossible, but it could be rather challenging if you don’t meet certain guidelines. Remember, lenders assess your credit score, employment history, income, home equity, LTV and current debt load to determine if you’re a good fit for a HELOC. The stronger your financial profile, the better your approval odds. Otherwise, you may have to jump through several hoops to get approved.
There’s a lot to love about HELOCs, starting with the flexibility they offer. Still, other options like home equity loans or personal loans could work better for your financial situation. A home equity loan provides a lump sum upfront, which can be easier to budget. Meanwhile, personal loans don’t use your home as collateral, eliminating the risk of foreclosure. Evaluate each option and assess the pros and cons. It’s also wise to compare options with multiple lenders to find the best funding source.
Yes, you can withdraw cash from a HELOC. A HELOC works like a credit card, providing access to funds up to a certain limit. You can pull funds during the draw period, which, in most cases, spans five to ten years. You only pay interest on the amount you withdraw, making HELOC a more flexible funding source. The funds can be used however you see fit, whether it’s for home improvements, debt consolidation, or to make a big-ticket purchase.
