Pros and cons of a home equity line of credit
Homeowners who want to tackle major home renovations or consolidate high-interest debt can tap into their home’s equity and take out a home equity line of credit (HELOC). Unlike home equity loans, which offer a lump sum, HELOCs are a revolving line of credit. You can borrow funds whenever you need them—similar to a credit card. You’re given a maximum borrowing amount based on the equity in your home—typically up to 85% of your home’s value minus any remaining mortgage payments. If this applies to you, below are four pros and cons to taking out a home equity line of credit.
Pros of a HELOC
Little to no closing costs
Closing costs for HELOCs are lower than what it costs to close a mortgage, as loan sizes for HELOCs are smaller than a standard mortgage. Closing costs for HELOCs typically run between 2% to 5% of the total line of credit and consist of origination fees, underwriting fees, and other administration fees. Depending on your lender, some of these costs are reduced or eliminated. For example, some lenders may waive origination fees or offer no cash due at closing.
Lower interest rates plus tax benefits*
Interest rates are already low, but HELOC rates are lower than common lending avenues, like personal loans and credit cards. Interest rates for personal loans range from 6% to 36% depending on credit score and financial history, and credit cards average around 16%. Meanwhile, some of the best HELOC rates fall below 5%. Interest can also be tax-deductible*, but there are restrictions. The Tax Cuts and Job Act of 2017 made several changes to individual income tax, including reforms on itemized deductions. But, interest paid on HELOCs can be deducted, only if the loan makes improvements on the taxpayer’s home used as collateral—and it must be their main home. Interest is not tax-deductible when used to pay off personal living expenses, like credit card debt.
HELOCs offer tons of financial flexibility. Depending on the amount borrowed, repayment periods are often longer, making them ideal for big-ticket projects or expenses. The timeline varies, but some lenders offer terms up to 30 years. And, you only have to make interest payments during the draw period, which is usually the first five to ten years of the loan’s lifetime. When the draw period ends, you begin making payments on principal and interest. You have the option to pay the principal amount, too, to lower the amount remaining during the repayment period.
Fewer restrictions on how you use funds
There are few restrictions on how you can use HELOC funds. Many people use HELOCs to pay for major renovations. Even though HELOCs are secured by your home, you don’t have to use them for remodeling. Sometimes, it can be beneficial to use HELOCs to pay off personal expenses because of their lower interest rates. For example, HELOCs can be used to consolidate debt, pay off substantial medical expenses, or help pay for tuition—to name a few.
Cons of a HELOC
Your home is collateral
Unlike credit cards or personal loans, which are unsecured, HELOCs are secured, which means a form of collateral is required to borrow funds. Secured loans often have lower interest rates but assume some risk. The upside of your home being used as collateral is that the more equity you’ve built, the more you’re capable of borrowing. The downside of your home as collateral is if you’ve missed a few loan repayments, unfortunately, your home could be subject to foreclosure.
Your home’s equity is reduced
As previously mentioned, HELOCs involve borrowing from your home’s equity. When you build equity and can borrow what you need, it’s beneficial. However, if housing prices decrease and the value of your home drops, this could lead to you owing more than what your home is worth. And, if you owe more than what your home is worth, this reduces your borrowing capability.
Variable interest rates
Unlike home equity loans, which offer fixed interest rates, HELOCs offer variable interest rates. The interest rate fluctuates over time—usually at the mercy of the Federal Reserve. The Federal Reserve is responsible for setting the rates that banks charge each other for overnight loans to meet reserve requirements. The prime rate is another benchmark rate and the most commonly used determinant of HELOC rates. The prime rate is typically 3% higher than the federal fund rate, and lenders use this to set their rates. When the Federal Reserve changes the federal funds rate, other loan rates increase or decrease.
Possibility of overspending
Unfortunately, HELOCs are not interest-only payments forever. During the draw period, you’re required to make interest payments. It can be easy to forget how much you owe, especially when you have a draw period of ten years. When the draw period is over, you begin paying the principal amount of your loan, plus interest. If you’re not anticipating or accounting for the increase in monthly payments when your draw period ends, it can come as a financial shock.
Although it involves significant consideration, HELOCs can be a viable option if you have enough equity built in your home due to their flexibility and potential tax benefits. But, using your home as collateral can be intimidating for some. Examine your financial habits and see if a HELOC works for your situation. And remember, Georgia’s Own is here for your lending needs, with ReadiEquity LOC rates as low as 4.00% APR through August 31st.**
*Please consult your tax advisor.
**Rates are variable and subject to change. Your Annual Percentage Rate (APR) may differ from the one shown and will be based on your credit worthiness and loan to value. Rate may not exceed 18% at any time. Property and/or flood insurance may be required. Terms, rates, and conditions are subject to change without notice.