Property owners who want to check into their home’s equity to consolidate debt with high interest or finance home improvement projects often decide to take out a home equity line of credit, which is called HELOC.
Unlike a home equity loan that let you borrow a lump sum, a HELOC offers a line of credit you can borrow when you need to. Like credit cards, HELOCs also come with changeable interest rates, and your monthly paymentdepends on how much you borrow at any given time and your current interest rate.
HELOCs is popular because they use to make good financial sense, says Sean Murphy, AVP of equity lending at Navy Federal Credit Union.
“Specifically, if you are someone who is looking for a home improvement or debt consolidation loan with lower interest rates than personal loans or unsecured products, a HELOC may be right for you,” he says.
Advantages of a home equity line of credit
Home equity lines of credit usually lends you up to 85 percent of your property's value, which means these loans is not applicable for consumers who don’t have considerable equity. You also need good credit to qualify, and you will need an approved income to repay your loan.
If you’re a candidate for a HELOC, here are some of the biggest advantages:
Interest rates have been at or near all-time lows for a couple of years now, and home equity lines of credit let you take advantage of that fact. Financial attorney Leslie H. Tayne says HELOCs can have lower interest rates and lower initial costs than credit cards.
In fact, some of the best home equity rates fall below 5 percent. Meanwhile, the average APR on variable-rate credit cards is around 17.4 percent.
Even after the Tax Cuts and Jobs Act of 2017, you can still deduct interest paid on a home equity line of credit (or home equity loan) if you use the money for home improvements.
IRS says that interest payments on home equity products are not deductible “unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan.”
JPMorgan Chase Home Lending Representative Keosha Burns says another advantage of HELOCs is that you can “use what you need, when you need it.” Where home equity loans and even personal loans require you to take out a lump sum, you can use a HELOC in spurts if you want, only borrowing the cash you’ll use as you go along.
Tayne also points out that your monthly payment varies based on how much you’re borrowing, so you can wind up with a smaller monthly payment if you end up needing less cash.
Lastly, don’t forget that HELOCs often provide flexibility in terms of how you pay them off. Joseph Polakovic, owner and CEO of Castle West Financial in San Diego, says that this can include the option to make interest-only payments — at least at first.
The timeline for your HELOC can vary depending on how much you want to borrow and the lender you go with, but HELOCs can last for up to 30 years including a draw period and a repayment period.
Disadvantages of a home equity line of credit
First, you put your home up as collateral for the loan, which is also required to do with a home equity loan. While having a secured loan can help you secure a lower interest rate, you’re taking on some risk.
“Because you are borrowing against your home, if you can’t make your monthly payments, you risk foreclosure,” Murphy says.
Polakovic says that one disadvantage of HELOCs often stems from a lack of borrower discipline because they are so easy to access. Since HELOCs offer the chance to make interest-only payments, it’s also almost too easy to access this cash without feeling the pain of your decisions right away.
Lastly, don’t forget that you’re borrowing against home equity you may have worked hard to build up. This could mean spending more time paying off your house in the long run, but also paying more interest over the time you own your home.
If housing prices drop, borrowing against your home equity also means you could wind up owing more than your home is worth.
Murphy says that if you’re looking to spend as you go — and only pay for what you’ve borrowed, when you’ve borrowed it — a HELOC is probably a better option.
Home equity loans come with a fixed monthly payment and a fixed interest rate. This means you’ll know exactly how much you will owe each month, and you never have to worry about your interest rate going up or down.
A cash-out refinance replaces your existing mortgage with a new loan with a higher balance. Many lenders will let you refinance and borrow up to 80 percent of your home’s value, letting you receive the difference in cash.
Lastly, don’t forget to consider personal loans. This type of loan comes with a fixed monthly payment and a fixed interest rate, and you get a lump sum of money upfront like you do with a home equity loan. The big difference is personal loans are unsecured, so you don’t have to put your home up as collateral.