One key thing to ask if you’re considering a HELOC — that most people don’t

What is a HELOC, and how does a HELOC work?

But first, you need to understand the basics of a HELOC. A HELOC is a line of credit, borrowed against the equity in one’s home, where the house is used as collateral for the debt. They typically have 30-year terms, of which there’s a 10-year draw period, and a 20-year repayment period. The draw period is when the borrower is allowed to withdraw from their line of credit, and during this time, which is usually 10 years, the borrower is typically only required to pay the interest of the loan; after the draw period is over, the borrower can no longer use the line of credit and must repay the balance of the loan, including both principal and interest. This repayment period typically lasts 20 years.

HELOCs are generally variable-rate products, meaning their interest rates fluctuate based on the prime rate. But not all HELOCs are binding to a variable-rate structure, and that may be important to think about in this low-rate environment (see the latest HELOC rates you might qualify for here). 

A fixed-rate option on a HELOC

When shopping around for a HELOC, Greg McBride, chief financial analyst at Bankrate, says it’s important to ask lenders if they allow the option to fix the interest rate on an outstanding balance. This allows a borrower to lock in a portion of the outstanding balance at a fixed rate, or the ability to convert a HELOC to a fixed rate after the draw period. “This can be attractive if you’re looking to refinance an existing variable rate HELOC or expect to borrow all the money fairly quickly and want to lock in your interest rate,” says McBride. 

A fixed rate also means the monthly payment on your existing balance will not change, which can be valuable from a budgeting standpoint, as it offers greater certainty over the cost of additional borrowing during the draw period. “Particularly with interest rates poised for repeated increases in the next two to three years, a variable rate can present a lot of uncertainty about what this will cost and what your payments will look like in the coming months and years,” says McBride.

If you take out a variable-rate HELOC and want to convert it to a fixed rate because of a home remodel, a family emergency or to consolidate debt, you can either open a new HELOC or refinance your old HELOC by paying off the balance of the old loan and using funds from the new fixed rate loan in which your draw period would be reset.

Because interest rates are likely to rise in the next couple years according to economists and they may rise faster than we’ve seen in recent history, fixed-rate HELOCs are especially attractive right now, pros say (see the latest HELOC rates you might qualify for here). “But as the saying goes, ‘there’s no free lunch,’ so a fixed-rate HELOC may carry higher fees or penalties for closing out early, or have a higher rate to begin with, as the lender is bearing the risk of higher rates in the future,” says McBride.

Marguerita Cheng, certified financial planner and CEO of Blue Ocean Global Wealth, says the biggest benefit of a fixed-rate HELOC is the peace of mind of an interest rate that will not fluctuate. “In the short term, it may be a higher rate than the variable one but [you should still] pursue it if you want stability and predictability,” says Cheng. This, she says, is because you don’t want to have a large HELOC balance with a variable and fluctuating payment.

Fixed-rate HELOCs can also be a good option for homeowners looking to pay for home improvements rather than try their luck buying a new home in today’s competitive housing market.

So should you or shouldn’t you pursue a HELOC with a fixed rate? Basically, if the prospect of a variable rate and the likelihood of higher interest rates brings higher monthly payments that would stress your budget, it’s wise to look for a fixed rate that can alleviate that uncertainty. “The rate may be higher than if you took out a variable rate, but that could still pay off if interest rates move significantly higher in the next couple of years,” says McBride. 

Is a home equity loan or a HELOC the right choice for you? 

Home equity loans have fixed payments and interest rates and a lump sum of funds delivered up front, while variable HELOCs offer revolving credit lines, fluctuating payments and a limited amount of time to withdraw the loan money (known as the draw period). If you know exactly how much money you need for a specific reason, a home equity loan might make more sense than a HELOC, which presents the option to borrow over a longer period of time.

Pros and cons of a HELOC, and what to use a HELOC for

While a viable option for many, applying for a HELOC isn’t cheap. The upfront costs can include  an application fee, title search and appraisal that can cost hundreds of dollars, so if you’re looking for a small loan, there might be a better solution. And if you don’t repay your HELOC, you could mean lose your home.

Pros say that some of the best uses for a HELOC include home improvement projects, to pay medical expenses or to consolidate high-interest debt (see the latest HELOC rates you might qualify for here). But experts advise avoiding a HELOC for discretionary expenses.