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Home equity lines of credit (HELOCs) may become more popular as rising interest rates make alternatives less appealing. You may want to consider a HELOC in 2022 if you're looking to tap some of your home's equity—but first consider your current mortgage's interest rate, market rates, loan offers and how you plan to use the funds.
The HELOC moved to the back burner during the past few years. When the pandemic started and many found themselves jobless, some of the largest banks stopped offering HELOCs completely. At the same time, the Federal Reserve cut the target interest rate to 0%.
Even if they were able to get a HELOC, homeowners who wanted to borrow against their home often turned to a cash-out refinance instead—getting cash and replacing their mortgage with a new, lower-rate loan. Experian data from the third quarter of 2020 showed mortgage balances had increased by 2.4% compared with the previous year, while HELOC balances dropped by 7.2%.
But things look different at the start of 2022. Rising home prices mean homeowners may have more equity to tap. The Fed also signaled it will increase interest rates, and the Mortgage Bankers Association's Mortgage Finance Forecast from January 2022 predicts that 30-year mortgage rates will increase from 3.3% to 4% during the year.
If homeowners want to borrow against their equity (their home's value minus what they owe on their mortgage), a cash-out refi won't be as appealing if it means getting a new mortgage at a higher rate. Instead, a home equity loan or HELOC might become a top choice again.
How Do HELOCs Work?
A HELOC is a revolving credit line that allows you to borrow up to a set credit limit and uses your home as collateral. Similar to getting a credit card, opening a HELOC gives you the option to borrow money when you need it, but you are not required to borrow a lump sum. You only pay interest on the amount you borrow.
A few important things to keep in mind about HELOCs are:
- HELOCs have variable interest rates. Your interest rate and minimum monthly payment could increase or decrease after you take out a loan (called a "draw") from your HELOC. The loan may set minimum and maximum interest rates, but you should be prepared for rates to rise. Some HELOCs also give you the option to convert part or all of your balance into a fixed-rate loan.
- You can borrow money for a set time period. Your HELOC starts with a draw period—this is when you can borrow against the credit line and make interest-only payments. Once the draw period ends, you may be able to renew the credit line. If you choose not to or don't have that option, you'll need to refinance the loan, repay the full balance or make monthly payments over a repayment period. The specifics can vary, but draw periods may last five or 10 years, while the repayment period could be up to 20 years.
- Your credit limit depends on your equity. HELOCs generally let you borrow up to 85% of your home's value minus what you owe on your mortgage, although some lenders may have lower or higher limits. For example, if your home is appraised at $300,000, you owe $200,000 on your mortgage and you get approved for 80% equity, your HELOC's limit will be $40,000: (300,000 x 0.8) - 200,000.
- There are fees. You may have to pay a variety of appraisal, application and closing costs to get a HELOC. Additionally, there could be annual fees, inactivity fees, cancellation fees and draw fees.
Should You Get a HELOC in 2022?
In general, HELOCs can be a good option for certain types of projects. You may be able to borrow a lot of money with a relatively low interest rate for a home renovation or repair that will take months to complete, or have the credit line available in case of an emergency.
But they're not great for everything. For example, you might not want to use your home as collateral to borrow money for a vacation or purchase investments. As with your mortgage, falling behind on HELOC payments could lead to foreclosure.
You also may need a good credit score to qualify for a HELOC or get a low interest rate. And HELOCs may have higher fees than some other types of credit accounts.
Focusing on 2022 specifically, you'll want to consider how rising interest rates and the HELOC market could impact your decision.
- Rising interest rates: As interest rates increase, a HELOC may become a better option than a cash-out refinance. However, rising interest rates can also affect your HELOC's interest rate. Consider whether a fixed-rate loan might make more sense.
- Availability: Some of the big banks that stopped offering HELOCs at the start of the pandemic haven't started back up. You still want to shop around to make sure you're getting the best offer. But know that there may be fewer options, and a big demand could lead to long application processing times.
- Rising house prices: Increasing housing prices means you'll have more equity in your home. You may qualify for a higher credit limit or get a lower rate if you accept less than the maximum allowed. But also remember that prices don't always go up. If you borrow a lot, you could wind up underwater (owing more than the house is worth) if the market drops.
Alternatives to HELOCs
If you want to take out a large loan, there are several other options worth considering:
- Home equity loan: A home equity loan is an installment loan that uses your home as collateral. It could be a good option if you need the entire loan amount upfront or want a fixed interest rate.
- Cash-out refinance: A cash-out refinance involves applying for a new mortgage for more than your outstanding mortgage balance. You use the new loan to pay off your mortgage and keep the rest as cash. It could be worth checking your offers: Even if market rates are rising, you may be able to lower your rate if your credit or finances have improved since you got your mortgage.
- Personal loan: A personal loan is an unsecured installment loan. While personal loans may have higher rates than HELOCs, you don't have to use your home as collateral. Some personal loans don't have application or origination fees, which can lower your overall cost. You can compare options and get matched with a loan using Experian CreditMatch™.
The best option can also depend on how you plan to spend the money. For example, if you're consolidating high-interest credit card debt, a fixed-rate installment loan might make more sense than another line of credit. And a personal loan might be best if you want to borrow money for a wedding or other big expense without risking your home. But a home equity loan or HELOC could be best for a home improvement, especially if you're able to deduct the interest from your taxes.
Check Your Credit and Compare Your Options
Your credit history and scores can impact your ability to get a HELOC, home equity loan, cash-out refinance, personal loan and other types of credit accounts. You can check your Experian credit report and FICO® Score☉ for free to see where you're at. If you plan on borrowing money in the coming year, improving your credit could give you more options and help you save money on interest and fees.