What is home equity line of credit? A home equity line of credit is a line of credit that allows you to borrow money against the equity in your house whenever you find it necessary to do so. HELOCs, much like credit cards, offer variable interest rates. For a certain amount of time, your monthly payment will change based on your current interest rate and how much you borrow at any particular moment. This is similar to the way that credit card interest rates work. How does a home equity line of credit work?

The amount of equity you have in your house will determine how much of a maximum loan amount you are eligible for with a home equity line of credit, which is analogous to the credit limit on a credit card. You can use part or all of your available credit line, and the interest you are charged is calculated based solely on the amount you borrowed. So, you won't be responsible for paying any principal or interest on your line of credit if you haven't utilized any available funds.

Pros

While a HELOC allows you to borrow up to 85 percent of your house's worth, less any existing mortgage payments, these loans are not an option for borrowers who do not have a significant amount of equity built up in their property, which implies they do not own a significant portion of it outright. To qualify for the loan, you must have a solid credit history and income that can be verified. These are some of the most significant benefits of having a HELOC if you are eligible.

You may be able to get a good annual percentage rate

Even though interest rates on mortgages as a whole have been steadily climbing since 2022, the best rates for home equity lines of credit (HELOC) still typically have lower interest rates as well as lower initial costs than credit cards, which makes them desirable for purposes such as debt consolidation or ongoing home improvement projects.

Interest might be tax-deductible

Even after the passage of the Tax Cuts and Jobs Act of 2017, it is still possible to take a tax deduction for the interest you pay on a home equity loan or line of credit if you utilize the money to renovate your house. According to the Internal Revenue Service (IRS), interest payments made on home equity products qualify for tax deductions if the funds are used toward "buying, building, or significantly improving the taxpayer's house that secures the loan." Nevertheless, you may only deduct the interest paid on the mortgage up to a particular limit, which is determined by adding up the interest on both the first and second mortgages. You are also required to itemize your deductions.

You can borrow only what you need

One additional benefit of HELOCs is the ability to access cash whenever required. You may utilize a HELOC in bursts if you like, but home equity and personal loans force you to take out the whole amount immediately. Instead, you just borrow the money you need along with a HELOC. Because of this, they are an excellent choice when you do not have an accurate estimate of how much it will cost to repair the roof or renovate the kitchen. Should it turn out that you need less cash than you anticipated, your regular payment amount will be reduced accordingly.

Cons

The ability to borrow money against the value of your house is a useful choice, but home equity lines of credit (HELOCs) have a few drawbacks.

Home as collateral

A home equity line of credit is a secured loan, which means that your property serves as security for the loan. You may be able to receive a loan with a lower interest rate if you have collateral to back up the loan, but this comes with more risk.

Variable interest rate

Home equity lines of credit often come with interest rates that are subject to vary, in contrast to the set interest rates offered by home equity loans. This indicates that your rate may go up or down dependent on the choices made by the Federal Reserve; hence, even if you take out a HELOC at a low rate, you may be subject to much more interest when it comes time to make payments. This occurred in 2022, when the Federal Reserve launched a series of rate rises to fight inflation.

Overspending risk

HELOCs often suffer from the borrower's lack of discipline, one of the loan's disadvantages. Since home equity lines of credit (HELOCs) enable borrowers to make interest-only payments throughout the draw period, it is simple to obtain cash without carefully considering the possible negative effects on one's finances.

After the draw period, if you haven't been anticipating or planning for an increase in your monthly payments, it might come as an unwanted and unpleasant shock.