Is a HELOC a Good Idea?

How Does a HELOC Work?

A home equity line of credit is a revolving line of credit that gives you ongoing access to a portion of your home equity. Similar to a credit card, a HELOC allows you to draw money up to a set credit limit.

During the draw period, which can last up to 10 years, you may have a minimum payment that covers some of the principal balance or even have the option to make interest-only payments. However, you can make extra payments if you want to free up some available credit or keep your balance low.

Once the draw period ends, you'll enter the repayment period, which can last up to 20 years. At this point, you'll start making full principal and interest payments and can no longer draw from the credit line.

Learn more: What You Need to Know About HELOCs

Pros and Cons of HELOCs

As with any financial product, HELOCs come with both benefits and drawbacks for homeowners. Here's what to consider as you determine whether a HELOC is right for you.

Learn more: How Does a HELOC Affect Your Credit Score?

Should I Get a HELOC?

The decision of whether or not to apply for a HELOC ultimately depends on your situation and financial goals. But if you're not certain, here are some situations where it could make sense, along with some where it might be best to consider other options.

When a HELOC May Make Sense

• Debt consolidation: Using a HELOC to consolidate high-interest debt can help you save money on interest, especially compared to a personal consolidation loan. It can also reduce your monthly expenses, especially if you have a significant amount of debt and are having trouble paying your bills.
• Home improvements: One of the most common ways to use a HELOC is for home renovations or improvements. HELOCs allow you to borrow money as you need it, making it suitable for projects that might be completed in stages. Plus, if you use a HELOC to pay for home improvements, the interest may be tax deductible under certain circumstances. In addition, upgrades to your home can add to its value.
• Emergency expenses: If you don't have a robust emergency fund yet, a HELOC can serve as a financial safety net for unexpected costs like medical bills or major home repairs, providing quick access to funds when needed.
• Education costs: Using a HELOC to cover tuition or education-related expenses may be cheaper than private student loans. However, it might not be worth it if you or your child can qualify for federal student loans, which may offer lower interest rates and more relief options.

When a HELOC May Not Make Sense

• Lifestyle expenses: Vacations, entertainment and other lifestyle purchases can be expensive, but adding to your overall debt to pay for time away or various luxuries may not be worth the cost. If you can't afford the lifestyle you want on your income or what you have tucked away in a savings account, tapping into your home's equity is a risk you may not want to come home to.
• Buying a car: If you have good credit, you may be better off with an auto loan. While car loans also require collateral—the vehicle you're buying—there's no risk to your home if you fail to keep up with payments.
• Investments: Using borrowed money from your home's equity to invest is risky. If your investments lose value, you're still on the hook to repay the HELOC with interest.
• Everyday expenses: While a HELOC could help out in a financial pinch, it's not recommended to use one to indulge in overspending. If you're struggling to get by, consider other resources to get back on your financial feet.

Learn more: Best Ways to Use a HELOC

Qualifying for a HELOC

Eligibility requirements can vary depending on the lender, but here are some general guidelines to keep in mind as you prepare to apply for a HELOC:

• Credit score: The absolute minimum credit score required is typically 620, but some lenders may go higher. The score requirement can also vary depending on how much you want to borrow.
• Equity: You'll typically need at least 20% to 25% equity in your home, though some lenders may let you borrow up to 100% of your home's value.
• Income: You'll need to provide proof of income showing that you can pay back any debt you incur. In some cases, you may need to share two years' worth of income to show a stable employment history.
• Debt-to-income ratio: Your debt-to-income ratio (DTI) is the percentage of your gross monthly income that goes toward debt payments. Having a DTI below 43% will make it easier to get approved, but some lenders will let you go up to 50%.

Learn more: Requirements for a Home Equity Loan or HELOC

Alternatives to HELOCs

Before you apply for a HELOC, it's a good idea to research and compare other ways to accomplish your goals. Here are some alternatives to consider:

• Home equity loan: Home equity loans are installment loans that, similar to a HELOC, use your home as collateral to secure the loan. Another type of second mortgage, a home equity loan can be a good option if you need a lump-sum amount upfront and want a fixed interest rate.
• Cash-out refinance: With a cash-out refinance, you'll refinance your primary mortgage with a new, larger loan and receive the difference in cash. By refinancing your current mortgage, you may be able to lower your monthly payments and get better rates and loan terms.
• Personal loan: If you don't want to use your home as collateral, a personal loan might be a good alternative. They may have higher rates than HELOCs, but some unsecured personal loans have fewer fees than HELOCs, which can lower your overall costs. If you're looking for a personal loan, Experian can show you personal loans matched to your individual credit profile.
• Credit card: A credit card acts much like a HELOC, albeit with higher interest rates. That said, you can avoid paying interest altogether if you pay your balance in full each month. Additionally, you can earn rewards with some cards, and others offer introductory 0% APR promotions.

The Bottom Line

Whether or not you should take out a HELOC depends on your financial circumstances and needs. It can come in handy in certain situations, but it also comes with risks, the biggest of which is the possibility of losing your home.

Keep in mind that your credit score and credit history can impact whether or not you qualify for a HELOC at the best rates and terms. You can check your credit report and FICO^® Score^☉ for free before deciding whether a HELOC is right for you.