Is a Home Equity Line of Credit Good or Bad?

A home equity line of credit can be good or bad, depending on your financial situation. Here’s how to tell…

I bought a home a few years ago, and I have some equity available. I also have some credit card debt that I need to pay off and I want to do some renovations to the house. A friend told me I should use a HELOC, but when I did some research I found a bunch of horror stories about HELOCs forcing people into foreclosure. So, my question is should I ever use a HELOC or are they always a bad idea?
Derek J. 
Tacoma, WA

An expert answer from Consolidated Credit’s Financial Education Director

Here’s what Consolidated Credit’s Financial Education Director April Lewis-Parks has to say about using HELOCs.

So, you can’t just deem a Home Equity Line of Credit good or bad without taking your financial situation into account. Here are all the factors you have to weigh:

  1. How much other debt do you have?
  2. What do you want to use the money to do?
  3. Do you have a good enough credit score to qualify at a low interest rate?
  4. Could you get an unsecured personal loan at a good rate instead?
  5. How much job and income security do you have?
  6. Is the economy stable or are experts warning of a downturn in the market?

 

An example of when a Home Equity Line of Credit is a good idea

The economy is in a good place and home prices in your area are steadily increasing. You have good credit and steady income working for a stable company; you’ve been with them for five years. You want to use a home equity line of credit to fund a series of home improvement projects.

This is an example of when a HELOC could be a good choice. You’re borrowing against your home to improve your home; that increases your home’s value. So, the financing is really an investment on an existing asset.

There is also a benefit here to using a HELOC instead of taking out an unsecured loan. Home improvement budgets can vary widely, and what you think you will spend doesn’t always match reality. If you take out a loan and go overbudget, you could be stuck funding the rest of the project on high interest rate credit cards. Conversely, if you take out a big loan and don’t use the funds, you get stuck paying off debt you didn’t really need.

By contrast, a Home Equity Line of Credit gives you an open credit line; you can draw from it whenever you need it. So, you only take out the funds you need over time as you work to improve your home. That gives the HELOC an edge over a traditional loan.

Important Note: HELOCs and home equity loans are not exactly the same thing, although they are similar. A home equity loan gives you a one-time lump-sum disbursement. We had a similar question about home equity loans that we answered previously.

An example of when a Home Equity Line of Credit is a Bad Idea

You’ve run up $50,000 in debt your credit cards. You have a good job with a stable company, but your income is based on commission and sales are seasonal; there are news reports that the economy is volatile.

This is an example of a situation where using a Home Equity Line of Credit may be unnecessarily risky. It’s risky because you have several indications that you may fall behind with the payments. You have a volatile economy and unstable income. Any number of things could happen that could lead you to miss payments. Once that happens, you are at risk of the lender starting a foreclosure action against you.

The other issue with this use of a HELOC is the purpose. In this case, you purely want to pay off credit card debt. But that means you essentially just converted unsecured debt to secured debt. Credit cards are unsecured. That means unless the creditor gets a civil judgment in court, they can’t tap your assets to recoup their money. However, if you take out a HELOC to pay off the debt, now you have a secured debt. If you fall behind, you risk foreclosure.

This is what happened to Carol. She worked as a waitress and then when the Great Recession hit her income dropped significantly. She took out a home equity loan and ended up in a worse situation than when she started.

So, in this case, an unsecured personal loan would be the better option. You need a fixed amount of cash to pay off your credit cards. This type of loan wouldn’t increase your foreclosure risk. If you can’t qualify for an unsecured loan, then you’d probably be better off using a different solution. Call a credit counselor first to review your options.