4 questions to ask yourself before taking out a HELOC

Thanks to a number of economic challenges, including high (but cooling) inflation and a series of rate hikes by the Fed, borrowing money has gotten a lot more expensive recently. Whether it's credit cards, personal loans or mortgage loans, borrowers' interest rates are currently much higher than they were just one year ago. And with another potential Federal Reserve rate hike looming, borrowing could get even more costly soon.

But if you need to borrow money and have equity in the home you own, you may have a good option: a home equity line of credit (HELOC). A HELOC can be a valuable financial tool for homeowners because it allows you to tap into the equity you've built in your property at a rate that's typically much lower than you'd get with other types of loans. 

This money can be used for any number of purposes, from home improvements to debt consolidation or emergency expenses. Before you decide to take out a HELOC, however, you need to know what you're getting into. To determine whether this type of lending product may make sense for you, start by asking yourself the questions below. By asking these questions, you'll be better prepared to make an informed decision on whether a HELOC is the right financial move for your situation. 

Start by exploring some of the best HELOCs available here now.

4 questions to ask yourself before taking out a HELOC

Before you sign on the dotted line for a HELOC, it may benefit you to ask yourself the following questions:

What am I using the HELOC for?

Prior to taking out a HELOC, it's important to define a clear purpose for the money you're borrowing. Are you planning to use it for home improvements that may increase your property's value? Will you be using it to pay off high-interest debts or for educational expenses? Knowing your primary purpose will help you assess whether a HELOC aligns with your financial goals.

It will also help you determine whether a HELOC makes more sense than, say, a home equity loan. With a HELOC, you're accessing a line of credit that you can borrow from multiple times. The total amount borrowed is then repaid, with interest, after the draw period is over. If you need access to a lump sum of cash instead, a home equity loan or a cash-out refinance could be a better fit.

See how much you're eligible to borrow and the rates you can qualify for here now.

Can I afford a HELOC?

You should also ask yourself if a HELOC is affordable for you. To determine whether it fits in your finances, conduct a thorough examination of your current money situation. Calculate your existing debts, income and monthly expenses to determine whether you can afford the additional debt that comes with the HELOC. If you miss payments or overextend yourself by borrowing money with a HELOC, you could put your home at risk of foreclosure.

The amount of equity you have in your home also plays a role in affordability, as the amount of home equity you have will determine how much you can borrow. As part of your overall affordability assessment, be sure to calculate the equity, which can be done by subtracting your outstanding mortgage balance from the current market value of your property. Many lenders will let you borrow up to 85% of your home's equity with a HELOC, but use that as a guideline and be careful not to over-borrow, as it may lead to difficulties in repaying the debt.

What are the fees and costs?

One downside to HELOCs is that they can come with various costs, including application fees, closing costs, annual fees and potential early termination fees. This can make tapping into your home equity a lot more expensive than you initially expected, so you need to ask yourself what the associated fees and costs are for any HELOCs you're considering. 

By getting a clear picture of the fees and costs, you'll be better prepared to understand the true price tag of the HELOC and can compare it with other financing options.

What are the current interest rates?

The interest rate attached to a HELOC helps to determine how expensive it is to borrow against your equity, so it's important to know what the current interest rates are — and understand the type of interest rates you're being offered. As of July 25, the average HELOC rate was 8.58% nationwide, but rates can vary significantly based on the lender, your credit score and profile and other factors — so it's important to know what the average is for comparison's sake. 

Plus HELOCs can come with either fixed interest rates or variable rates. With a variable interest rate, your payments could increase over time due to changes in the market. And while a fixed interest rate will keep your payment consistent, you could be losing money if interest rates drop in the future. Both types of rates have their potential benefits and downsides, so do the research to determine what works best for you.

The bottom line

A HELOC can offer financial flexibility and access to funds for various purposes, whether you're renovating a bathroom, building an addition on your home or consolidating high-interest debt. But whatever you plan to use a HELOC for, it's vital to ask yourself the questions above before tapping into your home equity. By considering your financial situation and weighing the associated costs and risks, you can make an informed decision that aligns with your long-term financial goals.