Knowing you’re building equity over time is undoubtedly one of the most significant advantages of home ownership. There are many ways you can leverage the equity built. Many homeowners use that equity to secure a Home Equity Line of Credit (HELOC).

Savvy borrowers know the pros and cons of any lending solution — get up to speed on everything you need to know about HELOCs here.

HELOC Basics for Borrowers

Similar to a credit card, a HELOC is a form of revolving credit that uses the equity in your home as collateral. Equity is calculated using the difference between your home’s value and your existing mortgage balance. Borrowers can use their primary residence, second home, or investment property as collateral.

The line of credit can be drawn on as needed for any purpose. Unlike credit card payments, the interest paid on HELOCs is most often tax deductible, making it an attractive option to many borrowers.

HELOC interest rates are variable and calculated based on an index and a margin. Most banks use Prime Rate as their index for HELOCs. The margin is added to the index and remains constant throughout the life of the line of credit.

If you’re considering a HELOC, it’s essential to be aware of the advantages and the things to consider before moving forward. We’ve outlined the pros and cons of HELOCs below.

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Pros: Advantages of Home Equity Lines of Credit (HELOC)

Lower Fees and Costs for Borrowers

Though a mortgage may likely have a lower interest rate than a HELOC, the fees associated with a HELOC may be quite a bit less. Fees range from 2-5% of the loan value, and annual fees are minimal. Lenders won’t require a full appraisal for HELOCs under $250k. Whether they use an automated valuation model or drive-by appraisal, both have savings over a full walk-through appraisal.

Can Help Borrowers Avoid PMI With Smaller Down Payments

Utilizing a HELOC may be worth considering for borrowers looking to avoid PMI without a substantial down payment. Using what is often called a “piggyback loan.”   A piggyback loan is when a borrower takes two separate loans for one property. Most often, the first mortgage is for 80% of the property value, and the second loan is for 10%. Borrowers then provide the remaining 10% out of pocket as a down payment instead of 20%. You may also hear loans structured like this called 80/10/10 loans.

Peace of Mind and Flexible Use of Funds

Unlike many other types of loans, borrowers don’t need to justify their plans to use funds from a HELOC. Though it makes sense to be responsible with using these funds, as they are backed with your property, there are many situations where a HELOC is a better alternative to personal loans or credit cards. From family emergencies or medical bills to consolidating debt — many borrowers appreciate the peace of mind in knowing they have a safety net for the many unpredictable expenses life can present.

Cons: Things to Consider Before You Apply for a HELOC

Tempting Low Payments

Because borrowers are only required to pay interest charges during the draw period, it’s possible to have a large loan balance with a small payment requirement. This could be a drawback to borrowers who aren’t disciplined in making additional payments beyond the required interest only that is due each month.

At the end of the draw period, borrowers must pay interest and principal. Payments can increase significantly, and sometimes, a balloon payment may be due.

Experts recommend making payments towards the principal balance during the draw period to avoid uncomfortable spikes in monthly payments when the repayment period begins.

Only Revolving for Ten Years

Borrowers can only access their HELOC for a predetermined amount of time. In most cases, there is a 30-year model. Borrowers have a 10-year draw period and a 20-year repayment period. Once the 10-year draw period ends, borrowers can no longer draw from the line of credit and are responsible for interest and principal payments. With a longer application process than a typical credit card, needing to repeat the process every ten years can be a deterrent for some.

Interest Rates May Rise

Rates on HELOCs are variable and can go up or down based on decisions made by the Federal Reserve. Fluctuating interest rates can make it difficult for some borrowers to plan and budget. Although HELOCs shouldn’t be discounted purely based on the unpredictability of interest rates and payments, it is something to consider when weighing your options. Some banks offer an opportunity to convert the balance, or a portion of the balance, to a fixed rate loan before the end of the draw period, minimizing the potential for drastic payment changes.

Is a HELOC Right For You?

Ultimately, the property used as collateral is the most critical thing to consider about a HELOC. Because the bank can foreclose on the collateral in the event of nonpayment, using your primary residence does come with some risks to consider and plan for.

Already know a HELOC is right for you? Contact one of our loan experts today for a free personalized quote!