Is a HELOC a Good Idea?

A home equity line of credit, or HELOC, is a type of mortgage in which you borrow against the equity in your home. Your equity is the current value of your home, minus what you owe on your mortgage.

A HELOC is a revolving credit line, like a credit card. During a specified number of years, called the “draw period,” you may borrow up to your limit, repay some or all of the balance, then borrow again up to your limit. During this time, you are typically required to pay only interest. When this draw period ends, the repayment period begins, and you pay both principal and interest. The draw period usually lasts 10 years, and the repayment period often lasts 20 years.

You may spend the money borrowed from a HELOC on just about anything, though financial planners often say that it’s best to use a HELOC for expenses that maintain or increase your home’s value. Your house acts as collateral for the loan, which means you risk losing your home if you can’t keep up with payments. Weighing the benefits and drawbacks will help you determine if a HELOC is right for you.

• Flexibility. Unlike fixed loans, home equity lines of credit don’t require you to know exactly how much you’ll need to borrow. You can continue to draw from the line as needed, up to a certain limit, within the designated draw period. 

• Relatively low rates. Because the HELOC is backed by your home, interest rates are typically lower than personal loans and other types of unsecured debts. 

• You pay interest only on what you draw. If you took out a $30,000 fixed loan and used $20,000, you’d still have to pay interest on the remaining $10,000. With a HELOC, you’re only paying interest on the amount you draw. 

• You’re using your home as collateral. If you can’t keep up with your monthly payments, you could lose your home to foreclosure. 

• Borrowing limits are tied to your equity. If you haven’t been in your house for long, you might not qualify for a large enough loan. Lenders typically allow you to borrow up to 85% of your equity, though some have higher limits. 

A HELOC can be an excellent resource to pay for renovations that are tackled in stages over time. It’s suitable for extensive home projects because it allows you to borrow money as you need it and to pay interest only on money that has been spent. In contrast, a home equity loan gives you money in a lump sum, so it’s useful for a one-time expense such as a roof replacement. You pay interest on the full balance from the beginning, regardless of whether you have spent it.

Interest on a HELOC may be tax-deductible if you use the funds for home renovations — but consult a tax advisor to ensure you qualify.

• To use as an emergency fund. You’re encouraged to build an emergency fund to pay for big, unexpected expenses such as medical bills, major home repairs and periods of unemployment. But if you want to supplement your savings, you can open a HELOC as a backup. If you want to use a HELOC as a hedge against unemployment, you’ll need to open an account while you have a job, because you’ll need to document current income to qualify for a loan.

• To pay for education. Many parents of college students can take out parent PLUS loans. But if you and your child aren’t eligible for federal student aid, you could borrow from a HELOC to meet college expenses. Or a HELOC might offer lower interest rates and fees than a parent PLUS loan. Keep in mind that you risk foreclosure if you can’t pay the balance on a HELOC, while your home isn’t on the line with a parent PLUS loan.

• To consolidate debt. It’s tempting to use a HELOC to pay off credit cards and other debt with higher interest rates. But you should do this only if you can stick to a plan to pay off the debt without charging up your credit cards again.

While cash from a HELOC is yours to spend however you see fit, it’s probably not worth it to mortgage your home for expenses that don’t appreciate. Examples of this include:

• To pay for a vacation. It’s not worth risking your home to pay for a dream vacation. The best way to pay for a vacation is with your savings. There are also travel credit cards and buy now, pay later travel loans.

• To finance a wedding. If you can’t afford to pay for a wedding or honeymoon without putting your home on the line, it might be better to scale back.

• To buy a car. Auto loans are made for this purchase, reflecting a finance term that better suits the useful life of a vehicle. Putting your house up for a purchase that’s guaranteed to rapidly lose value, and possibly ending up paying for a vehicle long after it’s been retired, makes little sense.

• To start a business. There’s enough stress and financial risk in starting up a small business, even without putting your home on the line, and there are other financing options available.