Think a HELOC Is Your Safest Bet for Borrowing? Here's Why You're Wrong

You take on a certain risk when you sign up for a HELOC.

When you have a need to borrow money, there are different options you can explore. You could take out a personal loan, and if your credit score is solid, you might snag a competitive interest rate on one. But if you have equity in a home you own, you may want to borrow against it instead, as doing so could mean having an easier time qualifying and paying less interest.

As of the third quarter of 2022, U.S. homeowners had gained a collective $2.2 trillion in home equity compared to a year prior, according to data from CoreLogic. So these days, tapping your home equity may be a pretty feasible option.

Now if you're going to borrow against your home, you have choices. You could take out a home equity loan, or you could opt for a home equity line of credit, or HELOC. The latter option may be more flexible in terms of getting access to money. But here's why a HELOC could backfire on you.

More flexibility, but also, more risk

When you take out a home equity loan, you borrow a lump sum of money that you pay back in fixed installments over time. With a HELOC, you get access to a line of credit you can draw from over a specified period of time.

In some cases, though, you might get 10 years or more to tap your HELOC. And that's a nice degree of flexibility to have.

A HELOC could also be a good bet when you're borrowing for something like home renovations and your costs are tough to nail down. You might have a project you're estimating will cost between $20,000 and $30,000. That's a giant range. With a HELOC, you'd have the option to qualify for a $30,000 line of credit. And then, if you only end up needing $22,000 of that, you'd simply leave the remaining $8,000 untapped.

But while borrowing via a HELOC may seem appealing due to that flexibility, you should also know that HELOCs commonly come with variable interest rates. Home equity loans, on the other hand, come with fixed interest rates.

This means that the cost of your HELOC payments could rise over time if your interest rate increases. And with that, you run the risk of not being able to afford your HELOC payments, falling behind, and risking severe consequences, from credit score damage to potentially even losing your home.

Be careful with a HELOC

It's easy to see the appeal of HELOCs. But if you're looking to borrow against the equity you have in your home, then a home equity loan may be your better option.

This especially holds true these days. The Federal Reserve has been consistently raising interest rates since last year. The Fed doesn't set HELOC rates, but when its federal funds rate (the rate banks charge each other on a short-term basis) increases, consumer borrowing rates tend to follow suit.

So right now is an especially precarious time to be looking at a HELOC. And if you're the sort of person who doesn't like financial surprises, then taking out a home equity loan may be a far better choice.