A home equity line of credit (HELOC) allows you to access your home’s equity. Unlike home equity loans that have a fixed amount, HELOCs allow you to borrow what you need when you need it.

But is a HELOC a good idea? With lower rates than many other types of credit and the flexibility that comes with borrowing as you need, it can be a good idea. However, since it’s secured against your home, it can also be quite risky for borrowers who aren’t disciplined.

What Is a Home Equity Line of Credit (HELOC)?

A home equity line of credit is a type of second mortgage that provides you access to revolving credit based on the value of your home after accounting for your current mortgage balance. You can borrow against the equity you’ve built in your home.

Once you have a HELOC, you can borrow from it as you need and repay some or all of it monthly, like a credit card. However, unlike a credit card, a HELOC is secured against your home. This means that if you don’t repay the amount you borrow, you risk losing your home when your mortgage lender decides to initiate foreclosure proceedings.

Even though there’s collateral involved, lenders will check your credit history and other financials, such as your debt-to-income ratio, current home loan details, income, and more, to determine the terms you qualify for.

You can borrow funds from a HELOC during a “draw period,” which is typically ten years. At the end of the draw period, the outstanding balance will be converted into a loan, usually with a repayment period of 20 years.

How Much Can You Borrow With a HELOC?

The amount you can borrow depends on your existing mortgage debt and the value of your home.

Lenders look at the combined loan-to-value ratio (CLTV), which is how much you owe vs. the current value of your home. For HELOCs, lenders generally offer 80% to 90% CLTV.

Let’s say the lender is offering you a loan-to-value of 80%. If your current home price is $500,000, you’ll first multiply $500,000 by 0.80, which is $400,000. If you have a loan balance of $200,000 on your current mortgage, you’ll subtract it from $400,000. This means that the maximum amount you can borrow with a HELOC is $200,000.

Having a high HELOC credit limit doesn’t mean you should borrow the entire amount since it can be difficult to pay it off later.

Advantages of a HELOC

  • Low interest rates:  Because they are secured loans backed by the equity in your home, HELOCs usually have a lower interest rate compared to credit cards and personal loans, especially if you have a good credit score.
  • Flexibility: You can use the funds for any purpose you choose, including making a large purchase or paying off other debts.
  • Long draw and repayment periods: You can usually draw money from a HELOC for ten years, during which you can choose to pay only the interest each month. The repayment period is usually quite long, often 20 years or more.
  • Borrow what you need: You can borrow what you need when you need it, like a credit card.

Disadvantages of a HELOC

  • Risk of foreclosure: Just like your primary (first) mortgage loan, your home is collateral for a HELOC. If you fail to repay as per the terms, you risk foreclosure.
  • Variable interest rate: Unlike home equity loans, which are typically fixed-rate second mortgage loans, HELOCs come with a variable interest rate that is based upon some interest rate index, such as the Prime Rate or the London Interbank Offer Rate (LIBOR). This means that your rates can increase over time if economic and financial market conditions change.
  • Higher payments: At the end of the draw period, your payments can be higher, especially if you’ve made interest-only payments during the draw period. This is because you’re paying back the principal, in addition to ongoing interest, until you pay off the entire loan.
  • Minimum withdrawals: Some HELOCs come with minimum withdrawal requirements. This means that you’ll have to pay interest on the amount you borrow, even if you don’t need the funds.

Home Equity Line of Credit (HELOC) vs Home Equity Loan: Key Differences

A HELOC is a revolving line of credit, very similar to the revolving credit line on a credit card, and it allows you to tap into your home’s equity as you need it. HELOCs come with variable interest rates, which means that your payments may rise if interest rates rise in the future.

A home equity loan is like a conventional installment loan. You’ll receive a lump sum loan at the beginning of the loan and then start to repay the loaned funds back shortly after, along with interest, in monthly installments over a fixed period of time. Home equity loans have fixed interest rates, so they provide more predictability.

Is a HELOC a good idea? That depends on your financial needs, whether you’re comfortable with variable rates, and if you have a plan for repayment.

Should You Get a HELOC?

HELOCs can be a viable option if you have built sufficient equity in your home and need access to cash regularly, in smaller amounts, over a period of time for home renovations or other purposes. For instance, it may also be a good idea if you plan to use the funds to improve your financial position, such as by making renovations and efficiency upgrades that increase the value of your home.

On the other hand, HELOCs can also be risky because of variable interest rates. If interest rates rise during the repayment period and you can’t pay back what you borrowed, you risk foreclosure and eventually losing your home. HELOCs also require a credit check, which means that if you don’t have good credit, you may pay more in interest.

Consumers may also try to use a HELOC to purchase another property, but debt expert and founder and managing director of Reichert Asset Management, Brad Reichert, cautions against this. “While some real estate investment salespeople may suggest using a HELOC or home equity loan for the down payment on another second home or investment property, this is never advisable,” shares Reichert

“If you get in over your head on the second property and can’t afford to make the monthly payments on your HELOC once the repayment period begins or interest rates rise significantly, you risk losing your primary home in the process,” he cautions.

If you’re still wondering, “Is a HELOC a good idea?” we recommend weighing the pros and cons and speaking to your lender to determine which equity product is best for you.

Alternatives to a HELOC

If a HELOC isn’t right for you, there are other types of loans to consider:

  • Cash-out refinance: With a cash-out refinance, you’ll get a new loan with a higher balance to replace your existing mortgage. You can get the difference in cash to use for any purpose you choose.
  • Home equity loan: If you need a lump sum of cash to pay off debt or make a large purchase, a home equity loan allows you to borrow against your home’s equity all at once. The loan comes with a fixed interest rate and a fixed-term repayment period.
  • Personal loan: If you don’t want to use your home as collateral, it’s best to borrow a personal loan. However, a personal loan comes with a higher interest rate compared to HELOCs.

Get a Home Equity Line of Credit  

A home equity line of credit (HELOC) can be a good option for homeowners with substantial equity who want flexible access to cash. You can borrow what you need and then pay it off. However, if you’re not disciplined or you borrow a larger loan amount, you may find it difficult to keep up with monthly payments along with your regular mortgage payments during the HELOC repayment period, when principal and interest are due.

With your home as collateral, HELOCs can also be risky. When considering this option, take time to learn how a HELOC works, how much you owe on your first mortgage, think about the potential risks, your financial needs, and whether you’re comfortable with variable interest rates.