Do you need money for a series of home improvement projects or other irregular expenses? A home equity line of credit (HELOC) is a popular way to pay for these types of costs, but it might not be the best option for you. Consider these alternatives, which might better suit your purposes.
Key Takeaways
- A HELOC is just one of many ways homeowners can borrow money to cover irregular expenses.
- One of the biggest reasons to consider a different type of loan is to get a fixed interest rate instead of a variable interest rate.
- Other reasons include not being able to afford the monthly payments, not having good enough credit, and wanting to refinance your first mortgage at the same time.
- Every HELOC alternative has its own advantages and disadvantages, which might include higher closing costs or a shorter loan term.
0% Introductory Interest Rate Credit Card
Purpose: Credit cards with a 0% introductory interest rate are best used for short-term borrowing.
Method: If you have a high credit score and a low debt-to-income (DTI) ratio, you might be able to use a credit card as a HELOC alternative. You should look for cards with a 0% introductory annual percentage rate (APR) on purchases, then choose the card with the longest introductory period.
Pros: A 0% introductory APR credit card is even less expensive than a HELOC and the introductory period may also be longer than the low interest rate introductory period offered by some HELOCs.
Cons: To avoid losing the 0% introductory rate on your credit card, you generally can’t be late more than 60 days on a single monthly payment. Furthermore, while you are only required to make the minimum monthly payment on the card, you will actually have to make fixed monthly payments that are large enough to pay off the entire balance before the introductory period expires. If you don’t, you’ll suddenly be hit with high interest payments. Paying the entire loan back during the introductory period means that you’ll have much less time to pay back your loan than with a HELOC.
Reverse Mortgage Line of Credit
Purpose: A reverse mortgage with the proceeds taken in the form of a line of credit is best for older homeowners who don’t want to make monthly payments.
Method: To qualify for a home equity conversion mortgage (HECM), which is the most common form of reverse mortgage, you must be 62 or older and have a considerable amount of home equity, according to the U.S. Department of Housing and Urban Development (HUD). While HUD does not specify how much home equity is considered “considerable," the American Advisors Group puts the amount at between 50% and 55%.
Pros: The unused portion of your line of credit grows over time. You won’t lose access to a HECM line of credit if your home’s value or the economy’s performance takes a hit. You don’t need an income or a particular credit score to qualify. You may be able to change your reverse mortgage payment plan if you later decide you’d prefer to get regular monthly payments.
Cons: A reverse mortgage requires far more equity to qualify than a HELOC does. Reverse mortgage fees aren’t cheap. These loans can be tricky to understand (to the point where some reverse mortgages are considered predatory). They can also create problems for non-borrowing spouses. You’ll need a crash course in the pros and cons of reverse mortgages before you take one out.
Cash-Out Refinance
Purpose: A cash-out refinance is best for homeowners who aren’t happy with their existing mortgage.
Method: A cash-out refinance is a type of first mortgage. It replaces your existing first mortgage (the one you used to buy your home or do a rate-and-term refinance) with a new, larger first mortgage. Your closing costs come out of the loan proceeds and then you can do whatever you want with the rest of the money.
Pros: A cash-out refinance could be a wiser option than a HELOC if you can get a better interest rate and you want the predictability of borrowing at a fixed rate. You’ll also have just one loan to pay back.
Cons: If your new mortgage will have a longer term than your existing mortgage, you could pay more interest in the long run despite getting a lower rate. Also, your closing costs on a cash-out refinance will likely be similar to those on a conventional mortgage loan, 2% to 5% of the amount you borrow, while with a HELOC lenders sometimes waive the closing costs. For example, Bank of America pays all closing costs on HELOCs of $1 million or less.
Home Equity Loan
Purpose: A home equity loan is best for those who want to borrow a lump sum at a fixed interest rate.
Method: A home equity loan might make more sense than a HELOC if you can figure out the total amount you want to borrow. With a home equity loan, you’ll have a fixed interest rate with regular monthly payments. Your loan will be secured by your home, and your loan amount will be based on your home’s value, your credit score, and your DTI.
Pros: As it is secured by your home, a home equity loan will usually have a low interest rate. U.S. Bank had fixed rates of 7.20% for a 10-year term and 7.15% for a 15-year term as of January 2023.
Cons: The interest rate will typically be higher than a HELOC’s initial interest rate. As with any first or second mortgage, you can lose your home if you can’t pay back your home equity loan. If you choose a 30-year repayment period, your total interest could be substantial.
Can’t choose between a home equity loan and a HELOC? You may not have to. Some lenders offer a HELOC with a fixed-rate option.
What Are My Options if I Don’t Qualify for a HELOC?
If you don’t qualify for a HELOC because you don’t have enough home equity, consider a personal loan or shop around for a 0% introductory APR credit card. If your credit score is too low for either of those options, but you have a 401(k) plan, a 401(k) loan may be possible.
Can You Get a HELOC if You Already Have a Mortgage?
Homeowners regularly get HELOCs, also called second mortgages, while they’re still paying down their main mortgage, also called a first mortgage. To qualify for a HELOC when you already have other debts secured by your home, you’ll need to have the right loan-to-value ratio. If you already owe 85% of what your home is worth, you may not be able to get a HELOC, but limits vary by lender.
What Are the Drawbacks of a HELOC?
A HELOC can hurt your finances. When interest rates go up, your payments will increase and possibly become unaffordable. Making interest-only payments during the draw period can lead to payment shock when you have to start repaying both principal and interest, and it’s easy to spend beyond your means when you have access to credit with a relatively low interest rate.
The Bottom Line
HELOCs are just one of many borrowing options you might consider as a homeowner. If you’d prefer the stability of a fixed interest rate, a home equity loan may be a better option. In other circ*mstances, a low-interest credit card, reverse mortgage line of credit, or cash-out refinance might work better for your situation.
