Is a HELOC a good idea? How to decide

Homeowners often ask: Is a HELOC a good idea? After all, a home equity line of credit effectively offers those in need of cash a revolving line of credit that they can use to consolidate debts or make large purchases. This line of credit is secured by the borrower/s residence.

Operating similar in practice to a credit card, a HELOC provides the option to borrow up to a preset limit for a predetermined number of years known as a draw period (generally 10 years). During this period, you’ll typically make just interest payments on the balance, which you can also repay in part if you need more funds to draw on. At the end of the draw period, a repayment period (typically 20 years in length) starts, during which both principal and interest payments come due.

All that being said, and given that you can spend any funds borrowed for a wide variety of purchase options, you’re probably wondering: Are HELOCs a good idea – and should I get a HELOC now? The answers, as you’ll see, depend entirely on your individual financial situation, living circumstances and personal needs.

HELOC benefits and risks

So are HELOCs a good idea? It’s important to note that there are both upsides and downsides attached with signing up for one. Let’s take a closer look at pros and cons of using a HELOC and what financial factors and variables that you’ll want to consider as you weigh the decision.

Should you get a HELOC?

Before applying to receive a HELOC, you’ll want to consider a number of different factors to determine if one is right for you.

Eligibility requirements

Prior to submitting an application, it’s important to understand the qualifications that you’ll need to meet in order to successfully secure a HELOC on your property. Note that such requirements may further vary by individual lender. On the bright side, even individuals with less of a financial history or lower credit scores may still potentially be eligible to get a HELOC, even with bad credit.

Sample qualifications that you’ll need to meet include:

• Credit score: A snapshot of your financial history – the higher your number the better. Generally, lenders will require a score of 620 or higher from borrowers in order to qualify for a HELOC.
• Debt-to-income ratio: Your DTI gives lenders a sense of how much income that you’re spending on debt, and if you’re a good candidate who’s likely successfully repaying the loan. Typically, a DTI of under 40% is recommended in any circumstance.
• Documentation: You’ll often need to verify your income (generally done through pay stubs, W2s for 2 years, year-to-date earnings, etc.) to be eligible as well. If you are self-employed, keep in mind you may be required to furnish 2 years’ worth of federal income tax returns and K-1s. Note that earnings from pensions, investments, Social Security benefits and rental properties can help you qualify.
• Personal information: Details on your full name, date of birth, Social Security number, recent addresses, current employer, a government-issued photo ID, etc.
• Property documents: Info on the property that you plan to take out a HELOC against such as a current mortgage statement, up-to-date property tax information, details on home insurance, etc. Of course, if you own your home outright, no mortgage statement is needed.
• Additional documentation: Sample items that may also be requested could include (but are not limited to) a current tax return extension, trust agreements, title or flood insurance policies, copies of homeowners association statements or insurance policies, etc.

Borrowing limits

The amount of equity that you hold in your home directly impacts the amount of money that you can borrow with a HELOC. For instance, most lenders generally allow you to borrow sums that total up to 85% of the amount of equity that you currently have in your house, though certain individual lenders may extend higher limits.

As you consider whether a HELOC a good idea for you, don’t forget here: You’ll want to consider how the amount of home equity that you can access compares to the total amount of funding that you’re hoping to obtain. Depending on how long that you’ve been in your home and how much money that you need, you may wish to look at alternative financial products.

Existing debt

Before you apply for a line of credit, you’ll also want to reflect on your current financial situation and any outstanding debts that you may hold. That means not only reviewing interest rates, monthly payments, and financial liquidity to get a sense of how much that you might be able to reasonably afford in terms of payments in any given month – it also means thinking about where it may make sense to pay down higher-interest debt holdings. Taking a closer look at your debt-to-income ratio is a good first step in making sure that you don’t get caught in a financial pinch here.

When a HELOC may make sense

Depending on your personal living situation and financial budget, a HELOC may be a good idea, such as under the following scenarios:

• Scenario 1: You’ve built up a large amount of home equity in your property and could use funding more rapidly than home equity loans or refinancing options tend to provide.
• Scenario 2: You’re looking to finance and tackle home projects or renovations over a period of time and only borrow money and pay interest as needed.
• Scenario 3: You’re interested in the flexibility of drawing against a line of credit without incurring the higher interest rates and costs associated with a credit card.

When a HELOC may not make sense

Then again, there are also cases when a HELOC may not be a good idea for you or your family, including if:

• Scenario 1: You may struggle to comfortably afford payments or any added expenses due to future increases in interest rates if you have a variable rate attached.
• Scenario 2: You’re uncertain about your future career or income prospects, given the potential of taking on more debt.
• Scenario 3: Housing prices look to be on the decline, which could present problems if you hold limited equity in your house and drops in home prices may potentially leave you underwater, or owning more on the mortgage than the house is worth.

Is a HELOC a good idea for debt consolidation?

The short answer is yes – obtaining a HELOC can present you with a helpful way to pay off credit cards, personal loans, and other financial products that often come with higher interest rates attached. At the same time, you’ll want to be careful about budgeting for any monthly expenses and ensure that paying down balances doesn’t subsequently prompt you to run up additional and unnecessary debt. Used strategically though, a HELOC can prove a handy way to gain access to funds needed to improve your overall long-term financial situation.

Alternatives to a HELOC

Noting that myriad financial products can provide you with additional sources of funding when needed, it also helps to consider other solutions that can help you obtain extra cash.

• Home equity loan: As you compare a HELOC and home equity loan, it helps to understand the basics of how the latter works. Specifically, a home equity loan makes it possible for you to utilize the equity that you’ve built up in your property to date as collateral in exchange for receiving a lump sum of money from a lender. Note that any monies that you receive through the process can be put towards different types of purposes such as making property upgrades and home improvements. Any sums borrowed are repaid in monthly payments, but are charged on top of current monthly mortgage bills. It’s for this reason that home equity loans are often referred to as second mortgages, noting that you’d be responsible for making payments on both your primary home mortgage loan and home equity loan each month. Mind you: Should you choose to sell your home before your home equity loan is paid off in full, you’ll also be required to pay the remaining balance at closing.
• Cash-out refinance: When considering a cash-out refinance vs. HELOC, it helps to know as follows. If you were to do a a cash-refinance, you’d effectively be replacing your current primary home mortgage with a brand-new mortgage, leaving you with one updated monthly payment. Under its terms, you’d basically be taking out a new loan for more than you currently owe your present lender and receive any extra amounts back in cash after closing. You could then if you wished use some of the equity that you’ve built up in your property and add it on to a new mortgage.
• Credit card: Credit cards provide you with a revolving line of credit, typically at a far lower borrowing limit (and potentially higher interest rate) than you might expect to receive via a HELOC. However, if you’re looking for a way to pay for smaller items and improvements and can repay outstanding balances quickly, or stand to take advantage of 0% interest offers, they may present a compelling alternative.
• Reverse mortgage: A reverse mortgage, which you may also hear occasionally referred to as a home equity conversion mortgage (HECM), is for homeowners aged 62 or older. It allows you to use your home equity to pay off the remainder of your primary loan, and then use the rest of the money for whatever purposes that you’d like, like paying down living expenses, amassing savings, paying off debt, etc. Options are designed to help folks of retirement age access their funds and eliminate monthly payments.

The bottom line

As you consider the question of whether a HELOC a good idea for you, it’s important to consider several factors. For example: Contemplating how much equity that you have in your home, how you plan to use the money, whether you meet eligibility requirements, and how you’ll manage any debt. But given the many ways that gaining access to a revolving line of credit can help you consolidate debt or pay for a variety of home improvements or even everyday living expenses? There’s much to recommend a HELOC, provided that you’ve got enough equity on-hand to make the financing option work for you.

Interested in learning more about how a HELOC can help you pay for upcoming expenses and achieve your big-picture financial goals? Be sure to reach out and start your application today!