Home equity lines of credit (HELOC) allow homeowners with equity to borrow as much as 125 percent of their property's value. A HELOC is a line of revolving credit where borrowers can withdraw funds up to an approved ceiling, paying only on interest for a 10-year vesting period, followed by a 10 to 20-year repayment schedule. In some cases, the borrowed amount and interest on a HELOC can be required in-full at the end of the vesting term. The June 15, 2016 variable rate on a $150,000 HELOC was 3.25 percent.
It looks attractive, right? But since a HELOC uses their home as security, consumers should exercise exceptional care in borrowing prudently, tracking the variable interest rate, and monitoring for potential fraud.
1. Make Shrewd HELOC Withdrawals
A HELOC draw period can seem enticing to consumers. Like other forms of revolving credit, the money can seem free and easy at first, leading to extravagant spending of the bank's money. Some common uses of HELOC funds are for consolidating debt, financing a wedding, covering financial emergencies, making home improvements or paying off medical bills.
At the same time, writing a check from a HELOC account can seem breezy to consumers eyeing big-box purchases or impulse items. The disastrous housing crisis was in-part caused by lenders extending easy approvals for home equity products. HELOC balances, combined with the amounts owed on the original home loan, added up to underwater mortgages when property values plummeted.
Consequently, today's lenders are more cautious in capping the amounts on HELOCs so that the combined total of the balance owed on the original mortgage and the new loan are at 80 percent, rather than the 125 percent granted during the boom. A prudent borrower should limit the HELOC themselves by borrowing up to 70 percent, leaving themselves breathing room in the event of value fluctuations and increased borrowing rates.
2. Stay Informed of Interest Rates and Payments
Speaking of rates, HELOCs are pegged to variable interest rates. While today's rates remain in the ballpark of recent historic lows, the FED is eyeing slow but steady increases in the months ahead. For homeowners, increases in the rate may seem sudden and unpredictable. Borrowing too lean to the bone can spell disaster if the homeowner has no financial cushion to offset HELOC rate increases. Monitor your HELOC rates regularly to adjust to increases. Those looking at a HELOC to pay for long-term expenditures such as ongoing medical procedures or college tuition may fare better with a fixed-rate home equity loan.
3. Protect Yourself from HELOC Fraud
Unfortunately, homeowners can be vulnerable to identity theft which can lead to HELOC fraud, strapping them with loans in their name payed out to criminals. After stealing your identity, thieves can open a fraudulent HELOC or divert HELOC funds from your account. There are identity theft protection measures worth considering:
- Order a credit report annually and check your score for free at LendingTree
- Make online purchases only on trusted websites through a secure home network
- Avoid storing credit card numbers, social security numbers and other personal information at online sites
A HELOC can be a safe and sound way to use home equity if you understand the risks. Remember, consumers often find the best HELOC rates when they request free bids from competing lenders.