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September 29, 2023 Personal Finance

Pros and Cons of Using a Home Equity Line of Credit (HELOC)

A Home Equity Line of Credit, or HELOC is a line of credit where a person is able to tap into the equity they have built in their homes in order to use funds on home improvement or a variety of other things. It is similar to a Home Equity Loan, but functions more closely to a credit card. HELOCs can be a valuable resource, but it is essential to look into the advantages and disadvantages of one before deciding if its the right choice for you.

Pros of Using a HELOC:

A HELOC is Flexible: A HELOC is a “revolving source of funds, much like a credit card, that you can access as you choose,” meaning you can borrow, repay, and borrow again if needed during the drawing period. You can use these funds for a variety of purposes and only need to take as much as you need.

Tax Deductions: Depending on what you are using your HELOC to pay for, the interest you pay may be tax deductible. This makes it much more cost-effective. Before deciding on a HELOC, see if your planned expenses will quality for these tax deductions. Home renovations of debt consolidation may be options that offer these tax deductions.

A Variety of Uses: A Home Equity Line of Credit can be used for so many different expenses, making it versatile and valuable. For example, you can use a HELOC for education expenses, home renovations, debt consolidation, medical bills, or other financial emergencies.

Smaller Payments: During the draw period (typically lasting from 5 to 10 years), you can make payments on only interest. If you have a tight budget, this can be helpful to cut costs. This also means though that later payments would require greater budgeting.

Supports Building Wealth: As expected, your home’s equity can increase over time. This means that as you repay borrowed money, you can have future access to more funds. In terms of financial goals, this can be helpful with long term financial planning.

Cons of Using a HELOC:

Fluctuating Interest Rates: Instead of having a set interest rate, HELOCs come with variable interest rates. This changes your monthly payments depending on the market, making budgeting a bit more challenging.

Overborrowing: HELOC funds are easy to access. Sadly, this can often lead to overborrowing and putting your home equity at risk. Discipline in borrowing is essential because struggling to repay could mean putting your home at risk.

Accumulating Debt: If you are not careful, borrowing from your home can lead to increased debt instead of rising wealth. While a HELOC offers lower initial payments, if you only pay the minimum it may mean facing a larger balance once the repayment period begins.

Costs and Fees: In order to start borrowing from a HELOC, you may have to make closing costs or other fees. Be sure to understand these fees before you begin to see which option is the overall cheapest and works best for you financial needs.

Reduced Equity: Borrowing over and over again against your home’s equity takes away from your ownership of the home. This may impact your ability to sell or refinance the home in the future.

As we have come to see, a HELOC comes with great advantages, but also disadvantages that can occur if there is poor financial planning. Before deciding on a HELOC for your financial needs, keep in mind these pros and cons.