HELOCs can be useful for many different purposes, but it’s important you understand the pros and cons of a HELOC before you commit.
Pros and Cons of HELOCs
Pros Explained
Low interest rates: Because they’re secured by the value of your home, HELOCs tend to have much lower interest rates than other kinds of loans, often making it an affordable borrowing option. Get money when you need it: Unlike other loans that offer a one-time payout, you can withdraw funds from a HELOC multiple times as the need arises, so long as you’re within the draw period. Only pay interest on what you borrow: Like a credit card, you only pay interest on your outstanding balance. If you don’t draw the full amount from the HELOC, you won’t owe interest. Can be easier to qualify for than other loans: Because you have an asset securing the loan, some lenders may be willing to approve the loan even if you have less than perfect credit.
Cons Explained
Variable rates mean your costs could rise: Many HELOCs come with variable interest rates, meaning that, unlike a fixed rate, they can change. If rates rise, you could find your payments increasing. Upfront and ongoing fees: Many lenders charge an origination or similar fee when you set up a HELOC. They may also usually charge maintenance fees to keep the line active. Your home serves as collateral for the loan. If you fail to make payments on your HELOC, the lender could foreclose on your home, adding significant risk to borrowing. You must have sufficient equity: The amount you can borrow depends on the equity you’ve built in your home. If you have limited equity, your ability to borrow will be limited.
HELOC vs. Home Equity Loan
Interest Rates
An advantage to securing a home equity loans and a HELOCs with your home is that it greatly reduces the lender’s risk. That means these loans have some of the lowest rates of any type of debt. One important difference between the two is that HELOCs tend to have variable interest rates. That means the rate can change over time based on market rates. With a home equity loan, you usually have the choice of variable or fixed rates.
Access to Funds
An important difference between HELOCs and home equity loans is when you can access funds. HELOCs let you draw funds multiple times as the need arises. That makes them ideal for people who might need cash quickly or who need to withdraw cash multiple times. Home equity loans give a one-time distribution of cash, which makes them better for one-time expenses such as paying for a home renovation.
Fees
Both HELOCs and home equity loans include fees. Both loans usually carry origination fees and closing costs that you pay upfront. However, only HELOCs have annual maintenance fees that lenders charge to keep the line of credit open. Home equity loans don’t tend to have ongoing fees to pay.
How To Get a HELOC
If you think that a HELOC is right for you, here’s how you can find one.
Compare Lenders
The first thing to do when you’re looking for any type of loan is shop around and compare different lenders. Every lender will offer different rates, fees, and other features for their loans. If you take the time to look at a few different options, you might find one that’s offering a much better deal.
Gather Your Information
Before applying, make sure you have all the necessary documents ready. You’ll need things like:
Personal identification, including Social Security numberIncome information and employment history Home documents, including a recent mortgage statementProof of homeowners’ insuranceProperty tax billsInformation about other outstanding debtsA list of your assets and account statements
Submit an Application
Once you’re ready, you can submit an application for a HELOC. Provide all the requested documents and work with your lender to verify the details of your home value, employment and income history, and answer any other questions they might have.
Appraisal
If your lender approves you for a HELOC, they’ll want to confirm that your home is worth enough to properly secure the loan. They’ll order an appraisal of your home to determine its value. The result of this appraisal can play a role in determining how much you can borrow with your HELOC.
Closing
If the appraisal comes back and shows you have sufficient equity, the next step is closing. You’ll sign all of the loan documents and paperwork. You will have three days to cancel the HELOC if you change your mind.
Use Your Line of Credit
After the three-day waiting period, your HELOC is officially open and you can start accessing the line of credit. You will have a draw period—typically 10 years—from which to access the funds as needed. During this time, you will start making monthly payments to include a portion of the principal (the amount you borrow) plus accrued interest.
Alternatives to HELOCs
HELOCs are one option for homeowners looking to get cash out of their homes, but there are alternatives to consider.
Home Equity Loan
A home equity loan provides a one-time distribution of funds that homeowners can use for things like paying a large medical bill, funding home improvement, or consolidating debt. Home equity loans are typically fixed-rate loans and are ideal for one-time expenses. They’re not the best choice for situations where you might need to withdraw funds multiple times.
Cash-Out Refinance
A cash-out refinance lets you refinance your entire mortgage and take some of the equity out of your home as cash. For example, if you owe $200,000 on your mortgage and have a home worth $300,000, you could refinance your mortgage with a new, $250,000 loan to replace the existing loan and get $50,000 in cash. Like home equity loans, cash-out refinances are best for one-time expenses because they offer a one-time payout of funds. However, because they replace your entire mortgage, they tend to be most useful when you can refinance to a lower rate or want to trade an adjustable-rate mortgage for a fixed-rate one.
Reverse Mortgage
A reverse mortgage lets homeowners age 62 or older turn their home equity into a source of income during retirement. These loans are far more complex than HELOCs and other equity-based loans, so it’s important to do your due diligence before getting one. In general, they can be a good choice for older homeowners who need to supplement their income but aren’t useful for many other situations. Want to read more content like this? Sign up for The Balance’s newsletter for daily insights, analysis, and financial tips, all delivered straight to your inbox every morning! For example, if you have a home worth $100,000 and still owe $50,000 on the mortgage, you could get at most $40,000 from a HELOC because you must maintain 10% equity.
