Pros and Cons of a HELOC
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A Home Equity Line of Credit (HELOC) is a financial tool that allows a homeowner to borrow money using the equity in their home as collateral. As homeownership remains one of the most significant investments many people make, tapping into that equity can provide access to substantial funds. However, like any financial product, a HELOC comes with both advantages and disadvantages. We’re here to help you explore the pros and cons of a HELOC so you can decide if tapping into your home’s equity is the best financial move for you.
What is a HELOC?
Unlike a traditional loan where you receive one lump sum, a HELOC functions similar to a credit card. You’re approved for a maximum borrowing limit, and you can withdraw funds as needed during the draw period, which is typically five to ten years. During this time, you’re usually required to make interest-only payments. After the draw period, the repayment period begins, which can last up to twenty years, and you’ll be required to pay both principal and interest.
The Pros of Using a HELOC
Flexibility in Borrowing
A HELOC can offer unparalleled flexibility compared to other types of loans. Depending on the amount you borrow, repayment periods are often longer, making them ideal for larger projects and expenses. Also, you’re not obligated to withdraw the entire loan amount upfront, so you can take out only what you need, when you need it.
Lower Interest Rates
HELOCs typically have lower interest rates compared to personal loans or credit cards because they are secured by your home. This can make them a more cost-effective borrowing option for large expenses.
Little to No Closing Costs
Closing costs for HELOCs are lower than what it costs to close a mortgage, as loan sizes for HELOCs are smaller than the standard mortgage loan. Closing costs for HELOCs typically run between 2% to 5% of the total line of credit.
Fewer Restrictions on How You Use Your Funds
There are few restrictions on how you can use your HELOC funds. Many people use HELOCs to cover the cost of major renovations, but it sometimes can be beneficial to use your HELOC to pay off personal expenses (e.g. consolidate debt, pay off medical expenses, pay off tuition for school) because of their lower interest rates.
The Cons of Using a HELOC
You Use Your Home as Collateral
Unlike credit cards or personal loans, which are unsecured, HELOCs are secured, which means a form of collateral is required to borrow funds. While secured loans tend to have lower interest rates, they assume more risk. The downside of using your home as collateral is if you miss too many repayments, your home may be subject to foreclosure.
Variable Interest Rates
Most HELOCs come with variable interest rates, which means the rate can fluctuate over time based on market conditions. While initial rates may be low, they can increase significantly, making your monthly payments unpredictable.
Possibility of Overborrowing
The ease of access to funds can tempt some borrowers to overspend, leading to financial strain. Unlike a traditional loan, where you receive a fixed amount, a HELOC’s revolving credit structure requires discipline to manage responsibly.
When Using a HELOC Makes Sense
A HELOC can be a helpful tool when you need it. Consider using your HELOC to:
- Complete Home Renovations – Using a HELOC for renovations can increase your property’s value, potentially offsetting the cost of borrowing.
- Consolidate Debt –Consider consolidating multiple high-interest balances into one lump sum with your HELOC. This will ultimately make paying your monthly payments more convenient and potentially save you money in interest over time.
- Pay for Major Life Expenses – Events like college tuition or medical bills may justify the use of a HELOC due to its relatively low interest rates and high borrowing limits.
- Cover You During Emergencies – A HELOC can serve as a financial safety net for unexpected expenses, providing that you use it sparingly and repay what you borrow promptly.
When to Avoid Using a HELOC
Sometimes a HELOC may not be the best option for you. Here are some instances when you should avoid using a HELOC.
- Uncertain Financial Stability – If your income is unstable or you’re nearing retirement, the risks of taking on a HELOC may outweigh the benefits.
- Investing – Using a HELOC for investments, such as stocks or business ventures, can be risky. If the investment fails, you could lose both your investment and put your home at risk.
- Overspending Tendencies – If you struggle with financial discipline, the ease of access to HELOC funds can lead to unmanageable debt.
Tips for Managing a HELOC
If you think a HELOC is the best option for you, we want to make sure you are properly equipped with the best tips on how to manage it.
- Only Borrow What You Need – The best way to manage your HELOC is to resist the temptation to withdraw more than necessary and avoid excessive debt.
- Understand the Terms – Be sure to carefully review the HELOC agreement, including interest rates, fees, and repayment terms.
- Budget for the Repayment Period – Plan ahead for the higher payments that will follow the draw period to avoid financial surprises.
- Monitor Interest Rates – Keep an eye on rate changes and consider refinancing if rates become unfavorable so you can ensure you’re saving the most money on interest.
- Avoid Using It as a Long-Term Solution – A HELOC is best suited for short- to medium-term financial needs, not as a substitute for long-term financial planning.
The Bottom Line
A HELOC can be a powerful financial tool, offering flexibility and access to significant funds. However, it also carries risks, especially if you don’t manage it responsibly. Understanding the pros and cons, as well as your financial goals and circumstances is crucial to determining whether a HELOC is the right choice for you.
Ready to apply? Our team is here to walk you through each step. Apply online or make an appointment to visit your local branch location.