Home equity lines of credit, or HELOCs, can be a good choice for homeowners who need extra cash to make home repairs or improvements, pay off medical bills, finance a child’s education or meet other major financial needs.
But like any other type of loan that’s secured by your home, a HELOC shouldn’t be undertaken lightly. Failure to repay according to the loan terms could hurt your credit score and result in the loss of your home through foreclosure.
Home equity lines offer many advantages. They’re relatively easy to open if you have plenty of equity in your home. (Equity is equal to the current value of the home minus the total outstanding mortgage balances.) The interest rate also may be lower than the rate on a second mortgage, and you’ll pay interest only on the amounts you actually borrow at various times. The closing costs may be more affordable as well.
Home equity lines also have quite a few disadvantages. The interest rate is usually variable, so the payments can be unpredictable and may rise. You also may have to pay an annual fee just to keep the HELOC open, even if you don’t use any of the money.
Perhaps the biggest drawback is that if your home declines in value, you could end up owing more on your first mortgage and HELOC combined than your home is worth. This situation, referred to as being “upside down” or “underwater,” means you won’t be able to refinance your mortgage or sell your home without great difficulty.
Homeowners who have a lot of equity also should watch out for a new type of fraud in which thieves use the homeowner’s personal financial information to open up a HELOC or misdirect an existing HELOC and drain the equity out of the home.
Home equity lines can be useful financial tools, but it’s important not to treat your home like a piggy bank or automated teller machine.