As of the second quarter of 2023, household debt in the US rose to $17.06 trillion, with Home Equity Line of Credit (HELOC) debt accounting for $340 billion. One of the most frequent reasons a homeowner secures a HELOC is that they seek to borrow money against their home without having to refinance their existing mortgage loan while remaining flexible and not having to advance all the funds immediately.

Typically, a HELOC has a variable interest rate and interest-only monthly payments during the draw period, while a home equity loan usually has a fixed rate and is subject to principal and interest payments over a specified period of time. While some of this may sound attractive to those needing an extra line of credit, a HELOC is not without its challenges.

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1. Variable interest rates are difficult to manage on traditional loans and HELOCs

Any time you have a mandatory mortgage payment due every month, an increase in your interest rate will lead to you having to make a larger monthly mortgage payment. Significant rate increases could lead to a new minimum payment that could create financial hardship and possibly result in foreclosure.

» Learn how rising interest rates impact your reverse mortgage benefits

2. Payments at the end of the draw period are steep

The minimum monthly payment on a HELOC during the "draw period" is interest only. The draw period is the predetermined time that the line of credit is open-ended and funds are available to be advanced by the borrower. Once the draw period ends, the HELOC loan will switch from interest only to either a principal and interest payment where the borrower will begin paying the loan back over a predetermined period, or the loan will result in a balloon payment. If your loan has a balloon payment, the entire balance becomes due when the draw period ends. Either option can lead to hardship if the borrower has not taken the necessary steps to pay off the loan by the conclusion of the draw period. Failure to make the new principal and interest payments or the balloon payment will result in foreclosure.

3. Your loan must be paid off before additional refinancing

You must always read the fine print when considering taking out a HELOC. Many HELOCs come with an annual fee to have the loan in place, and some even have penalties for closing the loan before a specified period of time.

» Want to refinance your HELOC? See the benefits of refinancing it into a HECM

4. Reduced net worth and increased expenses

Any time you increase the amount you owe against your home, you are reducing your total net worth, as home equity is a factor in calculating an individual's net worth. This is something to consider if your business qualifications rely on net worth. Additionally, the mandatory monthly payment on the HELOC becomes a part of your monthly budget and will only increase as the outstanding balance on the line increases. Additionally, if the HELOC is not subject to a balloon payment and resets to a principal and interest payment, the mandatory monthly payment will increase substantially, which could cause the monthly expenses to become unmanageable and possibly lead to foreclosure.

5. Greater flexibility leads to increased risk

Although a HELOC gives the homeowner lots of flexibility to spend the money as they wish, they must be conscious of spending the available funds. A lender or bank may approve a borrower for a HELOC in an amount that is more than is ultimately needed. A HELOC can be a great tool if used prudently, and funds are spent on necessary items or home improvement rather than leisure and entertainment.

6. Your line of credit is not guaranteed

The lender or bank can freeze your access to the line of credit or eliminate the available funds at their sole discretion. If the housing market is in a bad cycle and property values are down, the lender or bank can temporarily or permanently cut off access to your line of credit, creating a significant hardship if you are counting on access to those funds.

Consider alternative financing options

Before securing a HELOC, exploring a full cash-out refinance of one's regular first mortgage is advised. A new first mortgage can be obtained with a fixed interest rate, whereas a HELOC cannot. With a cash-out refinance of your existing first mortgage, you can safely calculate and know your new monthly payment, eliminating the surprises associated with a HELOC.

Additionally, for those age 62 or older, a regular reverse mortgage may be the best long-term solution. While the loan would be more expensive to establish, the line of credit would be guaranteed, and the unused funds would grow in availability.

» Learn more: See our HELOC vs reverse mortgage comparison