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A home equity line of credit, or HELOC, is a second mortgage that lets you borrow against the equity in your home. Your equity is the current value of your home, minus what you owe on your mortgage.
Pros
Relatively low rates
A HELOC is backed by your home, which means that HELOC rates are typically lower than personal loans and other types of unsecured debts.
Flexibility
Unlike a typical fixed loan, HELOCs don’t require you to know exactly how much you’ll need to borrow. You can continue to draw from the line as needed, up to your limit, within the designated draw period.
This period usually lasts for 10 years, and you’ll only be required to pay interest (though it’s wise to make larger payments to chip away at the principal).
After that, you’ll enter the repayment period, when you can’t borrow anymore and have to pay both interest and principal. You’ll usually have up to 20 years after the end of the draw period to pay off the loan — resulting in a total HELOC term of 30 years.
You pay interest only on what you draw
If you took out a $30,000 personal loan and used $20,000, you’d still have to pay interest on the remaining $10,000. With a HELOC, you’re only paying interest on the amount you draw.
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Cons
Your home is collateral
If you can’t keep up with your monthly payments, you could lose your home to foreclosure.
Rates are often variable
HELOC interest rates change multiple times a year, which may make it difficult to project what your monthly payments will be in the future. However, you can circumvent this by choosing a lender that offers a fixed-rate HELOC option.
Borrowing limits are tied to your equity
If you haven’t been in your house for long, you might not qualify for a large enough loan. Lenders typically allow you to borrow up to 85% of your home’s value, minus your current mortgage balance, though some permit higher limits.
For example, if your home is valued at $400,000 and your mortgage balance is $250,000, you have $150,000 in equity. If you wanted to borrow 85% of your equity, you could access $127,500 through a HELOC.
When a HELOC may be a good idea
A HELOC can be an excellent resource to pay for renovations that you tackle in stages. It's suitable for extensive home projects because it allows you to borrow money as you need it and to pay interest only on the money you draw.
Interest on a HELOC may be tax-deductible if you use the funds for home renovations — but consult a tax advisor to ensure you qualify.
Some homeowners use HELOCs to consolidate debt, by paying off credit cards and other debt that carry higher interest rates. But only do this if you can stick to a plan to pay off the debt without racking up more.
When a HELOC may be a bad idea
While HELOC cash is yours to spend however you see fit, it’s probably not worth mortgaging your home for expenses that don’t appreciate. For example, getting a HELOC to help fund renovations to increase your home value makes sense, but we wouldn’t recommend using a HELOC to pay for a vacation, wedding or car. You should also avoid mortgaging your home for risky endeavors like starting a business.
Wondering whether another kind of home equity product is right for you? Compare HELOCs with home equity loans and cash-out refinancing.
NerdWallet writer Robin Rothstein contributed to this story.
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