A HELOC – or home equity line of credit – is a revolving line of credit that is secured by your home. As house prices have recently increased, many borrowers now have record equity in their homes to borrow from. Some therefore consider a HELOC thanks to relatively low rates (see the lowest rates you could qualify for here) and the fact that you only have to withdraw the amount you want, rather than taking the money in the form of a lump sum. But they’re not for everyone, and they come with risks, including the fact that if you don’t pay them back, you could lose your home. We asked experts to share the most important things to know about HELOCs before buying one:
1. You might not be able to get as much money as you think
Just because you have equity in your home doesn’t mean you can borrow against it. “Most lenders want borrowers to keep a 20% equity stake, so the total amount borrowed between your first mortgage and a home equity line of credit can’t exceed 80% of the home’s value. You can have 25% equity but only be able to borrow a fraction of it,” says Greg McBride, chief financial analyst at Bankrate.
2. You need to be careful about how you use a HELOC
Lenders typically won’t ask you what you plan to use the money for, but experts say the smartest uses for a HELOC include home improvements that increase the value of your home. On the other hand, if you plan to sell your home in the near future, you may want to curb a HELOC, as you will have to pay off the loan balance when the home sells.
3. You could soon receive a higher monthly payment
Most HELOCs are variable rate, so keep in mind that HELOC rates can increase. “Over time, your rate and monthly payment may change even if you withdraw the same amount of money each month. HELOC borrowers are likely to find themselves with higher interest rates by the end of this year than they currently face, as the Fed has signaled that it will begin raising the federal funds rate to from March,” said Jacob Channel, senior economic analyst at LendingTree.
So what could that look like? Holden Lewis, real estate and mortgage expert at NerdWallet, said: “The Fed could raise rates four times this year for a full percentage point increase. On a balance of $50,000, this would increase the interest-only monthly payment by $41.67.
4. You shouldn’t get caught up in low introductory rates – unless they make sense
“Some HELOC lenders offer attractive introductory rates that can be in effect for 6 to 12 months,” McBride says. Indeed, some lenders offer this kind of rate from less than 2%. “This is an ideal option for balances you plan to pay off soon and then keep as a backup emergency line of credit.” However, these introductory rates are increasing, so if you’re looking for a longer term HELOC, don’t let the low introductory rates fool you if it means you’ll end up paying more interest after the initial introductory period. .
5. You may be able to switch your HELOC to a fixed rate
Some lenders will allow you a one-time option to fix the interest rate on your outstanding HELOC balance. “This is a particularly advantageous feature in a rising interest rate environment,” McBride says. Not all HELOCs offer this option, you may want to look for one that does if you plan on wanting your interest rate to remain stable. “If you’re considering a HELOC, you should ask questions like, how often can the rate increase? Is there a cap on how much the rate can increase over a period of time,” says the Certified Financial Planner Jeanne J. Fisher.
6. You need to understand how reimbursement works
HELOCs are divided into two phases, the draw period and the redemption period. “The draw period usually lasts between 10 and 15 years and you can withdraw money there and pay off your balance as needed. It’s important to note that you may only have to make interest payments – not principal – during the drawdown period,” says Channel. Once the drawdown period is over, the repayment period begins and usually lasts between 10 and 20 years. You can no longer borrow from the HELOC during the repayment period, says Lewis.
seven. You have the right to cancel
If you decide a HELOC is not for you, be aware that the right to rescind gives you 3 business days after closing to change your mind and cancel. “Of course, you won’t have access to any funds until the 3-day termination period ends,” McBride says.
8. You don’t get a HELOC without taking a risk
HELOCs aren’t without risk, and if you don’t pay back what you owe, you can end up losing your home to your lender. “As a result, borrowers shouldn’t be rushing to get a HELOC and should carefully consider their ability to repay one before applying,” Channel says. There may be better options out there. “Using a HELOC to consolidate credit card debt or pay for college is attracting the attention of many financial advisers. You risk losing your home if you can’t make your HELOC payments, but you don’t risk you don’t lose your home if you don’t pay off your credit card or student loan balance,” says Lewis.
9. You need to compare lenders
HELOC rates vary quite a bit, so the pros say it’s important to get quotes from 3-5 different lenders. Learn about HELOCs from your existing bank since you already have a relationship with them, and compare rates from online lenders, the pros say.
ten. You have other options
A HELOC is by no means right for everyone. Some may want a personal loan, others a home equity loan, and still others another type of financing. This is the 411 on the difference between home equity loans and HELOCs, and which is better for home renovations.