3 important things to know before opening a home equity line of credit

With mortgage rates rising last year, accessing home equity by deducting cash when refinancing (the so-called cash outriff) has become less attractive.

Mortgage rates rose from nearly 3% in early 2022 to a peak of over 7% in the fall. According to the Mortgage News Daily, the average interest rate for a 30-year fixed-rate mortgage is currently 6.21%.

HELOC usage started to increase as the cash out reference decreased. By September last year, the lender had structured his HELOC totaling $214 billion, up from his $159.5 billion in the same period in 2021, according to CoreLogic.

“In a low-interest-rate environment, people were looking at cash-out refis,” Bellas said. “Now…a lot of people have mortgages with very low interest rates, so in order to refinance cash out, they end up paying. [a higher rate] with their full mortgage. ”

“Over the past 12 months, a significant number of people have chosen to adopt HELOC,” Bellas said.

HELOCs generally have lower closing costs compared to mortgages and home equity loans (which, like other fixed rate loans, have a set repayment period). Also, if you have good credit, you can borrow at a lower interest rate than a personal loan or credit card balance.

According to Bankrate, HELOC currently has a rate of 7.75%. According to CreditCards.com, this compares to his over 10% for personal loans (for consumers with high credit scores) and about 20% for credit cards.

However, like a mortgage, a HELOC is a lien on a home. In other words, the lender has the right to foreclose on the home if you don’t pay it back as promised.

David Deming, president of Deming Financial Services (Aurora, Ohio) and certified financial planner, said:

“It has to be a short-term bill that pays off in a limited period of time,” Deming said.

Here are three important things to consider before signing with a dotted line:

HELOC interest rates are generally variable. That is, it rises and falls based on the so-called prime rate, which banks use as a basis for setting interest rates on various loans. The Federal Reserve does not control the prime rate, but what it influences – interbank overnight lending rates – will eventually follow suit.

“It can be difficult to create a monthly budget because it fluctuates,” says Bellas.

The US is currently in an environment of rising interest rates, but that is expected to change over time. The Fed’s rate setting committee is meeting this week and he is expected to raise overnight lending rates by a quarter of a percentage point.

HELOCs typically only include monthly interest payments. In other words, the minimum payment amount is not the principal.

“If you don’t have a lot of surplus funds and you’re making interest-only payments, it can be difficult to find the cash and discipline to pay that balance,” Bellas said.

“I’ve seen people with $50,000 balances, and it’s still close to that after five years. [amount],” He said.

HELOCs typically have a “withdrawal” period during which the money can be withdrawn, often lasting 10 years, followed by a repayment period, say 10 or 20 years, during which both interest and principal payments begin. So if you’re only paying interest, your payments will skyrocket.

For example, according to InvestorsBank.com’s HELOC calculator, if you have a $50,000 balance, your interest-only payments will be $312.50, jumping to $593.51 over a 10-year repayment period.

If you have a balance on your HELOC when you sell your home, it must be paid off along with the home’s primary mortgage.

Homeowners may use HELOCs to pay off high interest debt such as credit card balances.

At first glance, it might make sense to move high interest balances to HELOC. But if you don’t plan to pay off the HELOC, you’re just delaying the inevitable, Bellas said.

“The real danger is reclassifying the debt and cutting its way out,” Bellas said. “There are probably bigger issues that need to be addressed.”