I love my HELOC (home equity line of credit). And I sort of hate it too. Why? Because this form of credit allows me to get whatever I want, and that can be a dangerous thing. Here are a few things to carefully consider before taking out a HELOC.
Know What’s On The Line
Because a HELOC is a line of credit secured to your home, that’s what’s on the line if you don’t pay. Because this is a secured loan, however, you often get a better interest rate than a regular line of credit. You only pay interest on what you use and the amount you can borrow actually increases as you pay off your regular mortgage, as the bank has approved you for a set amount.
As you pay down your regular mortgage, your credit limit goes up. In theory, you could pay off your entire mortgage and still be able to access up to $350,000 if you like.
No Spending Restrictions
As mentioned above, you can use your HELOC for whatever you like. Once you are approved by the bank, you answer to no one for what you spend the money on. So if the roof suddenly leaks or you’re short over the holidays, you can use your line of credit and access the money right from your computer or a bank machine.
It’s a great tool for an emergency fund, although most people get them when they buy a home that needs a renovation. There are a lot of kitchens paid for by HELOCs!
Other benefits include a competitively reasonable interest rate compared to other lines of credit. The fact that the credit limit grows means you can borrow more as the years pass and you pay down your mortgage, offering you more wiggle room.
While your bank will automatically withdraw any interest you owe on your HELOC every month, you can make principle payments any time you like. You can call the bank to get on a regular monthly payment program, or transfer money over any time you have spare cash. If your bank has a good web portal, moving money around on your HELOC is easy.
The Debt Downslide
Easy access to money is often a bad thing. Even if you’re good with money, a HELOC offers the potential for a lifetime of debt. Yes, you’ll pay down your regular mortgage, but you could keep racking up your HELOC as the years pass.
There’s no incentive for paying off a HELOC. Its up to you and your own self-discipline.
While the rate on a HELOC is better than a regular LOC, it’s often higher than your mortgage rate. So if you do pay down that conventional mortgage and yet keep borrowing, you will end up spending more long term.
Meanwhile, since the HELOC rate floats, you could end up at risk when interest rates go up.
How to Make Your HELOC Work
- Be cautious if your bank offers you a sky-high HELOC. Borrow only as much as you need.
- Try to do renovations, travel and other big purchases from savings, not a HELOC.
- As soon as you draw down on your credit line, call the bank to set yourself up on a payment program of at least a few hundred dollars a month.
- Avoid making extra payments on your conventional mortgage. Instead, put that money toward your HELOC.
- Keep an eye on how much interest you are paying each month. Put that amount (and your principal payment) into your monthly budget.
- When making long-term plans regarding paying off your mortgage, take the amount you owe on your HELOC into account.