Is a HELOC a good idea?

Home equity lines of credit (HELOCs) let you borrow against your equity on an as-needed basis. While these loans are a popular way for homeowners to cover expenses — like home repairs or debt consolidation — they’re not right for everyone.

Getting a HELOC can be a smart move if you have a good amount of equity and a clear plan for paying it off what you borrow. However, a HELOC does come with risks, especially considering that it uses your house as collateral.

If you’re wondering whether taking out a HELOC is a good idea, here’s what to know.

When a HELOC is a good idea

A HELOC can be a good idea if you need access to cash on a repeated basis and have good credit as well as a solid amount of equity, which can help you qualify you for competitive rates and terms.

Getting a HELOC to cover expenses can also be smart if you have stable income (or are expecting a raise or promotion soon). This would allow you to comfortably handle potentially higher payments down the line if your HELOC rate fluctuates.

When a HELOC might NOT be a good idea

HELOCs typically have variable rates, meaning your rate and payment could rise over time. If you have irregular income and aren’t sure you’ll always be able to handle your payments — or if you expect your income to decrease — then getting a HELOC generally isn’t a good idea.

You also might not want to take out a HELOC if your credit score is low, you have a lot of debt, or you don’t have much equity. Under these conditions, the rates and terms you’d qualify for could be cost-prohibitive.

How HELOC interest rates work

HELOCs tend to have variable rates, which means the rate you start with isn’t necessarily permanent. Instead, your rate will be tied to an index rate (usually the prime rate), and if that rate rises or falls, your HELOC rate will, too. This could happen as often as monthly, sending your payments up or down along with your rate.

In some cases, lenders offer HELOCs with fixed interest rate or the ability to lock in some or all of your HELOC balance at a fixed rate. If you want a fixed-rate option, you’ll need to shop around to find lenders that offer them.

Learn more: How HELOC interest rates work

Pros and cons of a HELOC

The biggest advantage of a HELOC is that it allows you to borrow against your equity and access funds through a revolving credit line. This means you can withdraw cash on an as-needed basis for a period of time — often 10 years, depending on the lender.

Because HELOCs are secured by collateral, they’re also less risky for lenders. This results in lower interest rates compared to many other borrowing products, such as credit cards. This can make a HELOC a smart tool for paying off other debts, as it can save you money on interest and help you pay off your balances faster.

HELOCs also charge interest only on the amount you actually withdraw, not your full credit line. You might even get to write off that interest come tax season if you use the funds to “build, buy, or substantially improve” your home, per IRS rules.

On the downside, HELOCs usually have variable rates, which means your payments can be somewhat unpredictable. And since your home is used as collateral, missing payments can lead to foreclosure. There are also often fees associated with HELOCs, and with their high limits and long withdrawal periods, they can tempt some borrowers to spend more than they should.

What to consider before getting a HELOC

HELOCs put your home at risk of foreclosure if you can’t make your payments, so it’s important to weigh the decision carefully before taking one out. Here are some important points to think about beforehand:

Your credit score

Your credit score will influence whether you qualify for a HELOC — you’ll typically need a score in the upper 600s to get approved. Your score also affects what interest rates you’re offered, which will have a big impact on your overall costs. HELOC lenders typically reserve the best rates for those with scores of 700 or higher.

While you might still qualify with some lenders if your score is on the lower end, this could also land you with a prohibitively high rate that makes it challenging to stay current on your payments. If your credit is less-than-stellar, you might want to work on improving your score before applying.

How much home equity you have

Having more equity typically equates to better rates and terms. Some lenders will allow you to borrow up to 90% or even 95% of your home’s value (minus your current mortgage balance). However, larger amounts like this create more risk for the lender, which usually results in higher rates. You’re typically better off aiming for 50% to 80% if you want the most affordable terms.

Your financial stability

How stable your income is should be a big consideration as you’ll need to cover your payments throughout your repayment term. Also keep in mind that rates and payments can fluctuate, so you might want some savings on hand to help manage these possible changes, too.

Best uses of a HELOC

The best uses of a HELOC are ones that leave you better off financially than when you took out the loan. This can include things like:

• Making home improvements, which increase your home’s value and give you more equity
• Paying off high-interest debts, as this can save you money on interest over time and get you out of debt faster
• Large, necessary expenses that you can afford to pay off before interest becomes prohibitive

What you shouldn’t use a HELOC for

Because HELOCs use your home as collateral, you shouldn’t use them for unnecessary spending, like paying for vacations or buying new clothes. A HELOC is best used only for necessary expenses or purchases that improve your financial situation in the long term (like paying off high-interest debts or investing in your property).

You also generally shouldn’t use a HELOC to cover daily living expenses. This indicates a bigger financial problem is at play, and getting into more debt could only worsen that. Instead, consider talking to a credit counselor or financial professional who can help you get your budget back on track.

Alternatives to a HELOC

HELOCs aren’t the only option if you need cash. Here’s how some popular alternatives compare:

Compare more: HELOC vs. home equity loan

How to decide if a HELOC is right for you

HELOCs can be a helpful financial tool, but they’re not right for every homeowner. Before deciding whether to get a HELOC, ask yourself the following questions:

• Can I handle a variable rate and payment — not just now, but in the long run?
• How stable is my income? Is it growing or shrinking year over year?
• What will I spend my HELOC funds on? Are those expenditures necessary?
• Can I commit to paying down my HELOC balance to avoid prohibitive interest costs?
• Can I avoid using my HELOC to spend frivolously or on things I don’t need?

These questions can help you get a better pulse on your current finances as well as make the best decision for your money in the long run.