HELOCs aren’t for everyone, though. Learn more about whether a HELOC might be right for you, and if not, what other options you may wish to consider. 

Is a HELOC a Good Idea for You?

HELOCs work a bit differently than most lending products you may be familiar with.  A HELOC is split up into two phases: a draw phase and a repayment phase. During the draw phase, you can borrow money and are only required to make interest-only payments. After a fixed time period, you’ll enter the repayment phase, when you’ll repay the money you borrowed either in full or over a specific time period. This unique structure makes it better for some purposes than for others. Here are some questions to ask to determine if a HELOC is right for you or not.

Do You Have Enough Equity In Your Home?

In order to be approved for a HELOC, you’ll need equity in your home. Many lenders will only allow you to borrow up to 85% of the home’s appraised value, minus the amount you owe on your mortgage. If you’ve just bought the home and only have a small percentage of equity, you may not be able to get a HELOC. 

Why Do You Need to Borrow Money?

There are many good reasons to use a HELOC, including:

To cover education costsRepairing or improving your homePaying for treatment for a major illness

Each of these are large, single events that may require several smaller payments over a short period of time. For example, you might need to pay for several medical treatments, or several semesters, or for completion of certain renovation milestones. These expenses lend themselves well to HELOCs.  It’s not a good reason, however, to use HELOCs to bridge constant cash-flow issues, such as if your income permanently dropped or your expenses permanently increased. This is just putting a short-term band-aid on something that needs a permanent solution.

Can You Prioritize Repayment?

Just about everyone who ever defaults on a loan doesn’t necessarily plan on doing so. Nevertheless, sometimes things happen: You lose your job, a family member needs more care, or you’re diagnosed with a chronic condition.  Either way, ask yourself whether you’ll be able to prioritize repaying your HELOC even above all other debts (besides your mortgage, that is). If you default on a HELOC, it’s possible you could lose your home.

What Are Your Other Options?

One of the reasons a home equity line of credit is a good option is because it is often much cheaper than the alternatives. A HELOC is secured by your home, and like other secured loans such as mortgages and auto loans, lenders often set lower rates. But if you can borrow the money you need elsewhere at a cheap rate without putting your house on the line, that might be a better option. 

HELOC vs. Other Home Equity Options

When it comes to borrowing money, HELOCs aren’t your only choice. Here are a couple of other types of loans that are similar, but may work better for you depending on your circumstances.

Home Equity Loan

Home equity loans are also secured against the equity you have in your home, similar to HELOCs. Unlike HELOCs that let you access money at will during the draw period and then repay it later, a home equity loan works much more like a traditional loan. You’ll get one lump sum of money, and start repaying it immediately.  You might prefer a home equity loan if you need to borrow money for a true one-time expense, like replacing your roof or consolidating high-interest debt.  That way, you can restart the repayment process right away instead of making interest-only payments at first. Since interest-only payments can drive up your loan costs in the long run, a home equity loan may be a fitting alternative. 

Cash-Out Refinance

A cash-out refinance lets you refinance your mortgage loan into a new, larger mortgage. You get the difference back as cash that you can use however you wish.  You might prefer a cash-out refinance if again, you’ll be making one large lump-sum payment with the money you’ve accessed. It can be especially advantageous if you can refinance your mortgage for a lower rate than your current one. 

How To Get a HELOC

Getting a HELOC takes a little bit more work than most types of credit. It’s a good idea to shop around for rates.  If you’re considering a variable rate, check and compare the term, as well as the periodic and lifetime caps, which determine the limit on interest rate changes at one time and throughout the loan term. Lenders will also use an index, like the prime rate, when noting how to raise or lower interest rates. Ask them which index is used, and how much and often those may change. Also check the margin, which is the amount added to the index, as well as if you have the option to convert your variable rate loan to a fixed rate some time down the road. Be aware that it can take some time to be approved for a HELOC. The lender has to not only check your qualifications, it must also check your home’s qualifications as well. This means they’ll send out an appraiser to provide an independent assessment of your home’s value.  If everything goes according to plan and you’re approved for the loan, you can expect the process to take about 45 days from start to finish.