Wouldn’t it be nice if you could remove the stress from big financial decisions? While eliminating stress completely isn’t always realistic, you can reduce it when it comes to deciding if a Home Equity Line of Credit (HELOC) is right for you.
As with any major decision you need to make, research is key. That’s why weighing the HELOC pros and cons can help you make an informed decision that suits your financial goals and wellness.
What is a HELOC?
Before we explore HELOC pros and cons, it’s important to first understand what a Home Equity Line of Credit is. A HELOC allows you to borrow money against your home, using the equity that you’ve built up.
The purpose of a HELOC is to provide you access to money for items like:
- Remodeling your home’s kitchen or bathroom
- Financing a new car
- Consolidating debt
Instead of getting the money in one lump sum, like you would with a home equity loan or personal loan, a HELOC provides you with a revolving line of credit. Much like a credit card, it allows you to use it as needed. In fact, you don’t even have to make any withdrawals. But if you do, the money you borrow will come from your home’s equity—the greater the equity, the higher the borrowing limit.
Once you withdraw funds from your HELOC, you’ll have to start paying back the amount just as you would a credit card–making monthly payments, including interest.
HELOC Pros and Cons
It’s essential to look at all aspects of a HELOC when determining if it’s the best option for you. While there are HELOC pros and cons to evaluate, the biggest factor at play is your financial wellness, especially at the time you apply.
For example, if you have equity in your home and have good credit standing, a HELOC can offer you:
- Access to a large pool of cash that’s readily available. If you are approved for a HELOC, you’ll likely receive a credit/debit card, a checkbook, or both from your lender, enabling you to access your funds whenever you need them.
- A boost to your credit score. Qualifying for a HELOC typically requires a credit score of 620 or higher. You may even see your credit score gradually rise if you make payments on time and stay on top of managing your HELOC.
- Possible tax benefits. With a HELOC, “you only pay interest on the amount you’ve taken out, and you’re only limited by the total amount of the loan,” according to The Wall Street Journal. Plus, in certain instances, HELOC interest may be tax-deductible if you’re putting funds from your HELOC toward major home improvements.
While there are many advantages to a HELOC, they may not always benefit your specific situation. That is why it’s so important to keep in mind that a HELOC uses your house as collateral. Because of this, it’s imperative to use your HELOC funds appropriately. You must be able to pay back the amount you borrow in the time allotted. If not, you may face foreclosure.
Here the risks that can come with a HELOC if you’re not financially prepared:
- Losing your home. Because your house serves as collateral, defaulting on a HELOC means you could lose your home if you fail to make your payments on time.
- Penalties and fees. You want to always read the fine print before you close on a HELOC. HELOCs can involve penalties and fees, including: annual fees, prepayment penalties, or inactivity fees.
- Risk of more debt: If you plan to use a HELOC to consolidate debt and pay off high-interest credit cards, just make sure you don’t rack up even more debt. According to Millionacres, a real estate investing website owned by The Motley Fool, “This strategy makes sense — unless the borrower irresponsibly accumulates more debt on the credit cards and ends up with even more debt than before.”
So, Is a HELOC Right for You?
Once you weigh the HELOC pros and cons, you can start to answer the question: Is a HELOC right for you?
According to Investopedia, if you use the money on “purchases that will improve your financial situation in the long run,” a HELOC may be a good option. Specifically if:
- You are using funds from your HELOC toward home improvement projects that could increase your home value. Plus, a HELOC put towards home improvements could have tax benefits.
- You have a lot of equity in your home. The more home equity you have, the more money you may be able to borrow with your HELOC.
- You have a good or excellent credit score, which could help you secure a lower interest rate.
- You have a solid financial history and are reliable when it comes to making monthly payments. Since your home serves as collateral with a HELOC, making payments on time and in full avoids putting your home at risk.
- You want to be prepared for any large expenses like weddings, cars, or loan consolidation, in addition to having a pool of money to dip into for emergencies like medical bills.
The bottom line: If you have weighed the HELOC pros and cons and can be prudent with your finances, a HELOC could be the right financial tool for you as a homeowner.
 Prosper does not provide tax advice. Please consult a tax advisor regarding the potential deductibility of interest and charges.