Common HELOC Mistakes and How to Avoid Them
By BankingMyWay.com Staff
A Home Equity Line of Credit (HELOC) can be a useful financing tool. It works essentially like a credit card with your home as collateral. Rates are often lower than credit cards and credit limits are often higher.
Because your home is used to secure the loan, it’s important to use a HELOC wisely. Otherwise, you could lose your home to foreclosure.
Here are some common mistakes people make when using a HELOC and how you can avoid them:
- Failing to scrutinize the terms of the loan. Taking out a second mortgage, which a HELOC is, is very serious business. In your fail to obtain financing, be careful to go over all of the loan terms carefully. Beware of introductory rates. HELOCs often offer “teaser” rates or introductory margins (percentage over the prime rate). After the introductory period, the rate or margin can increase significantly. Look for the “lifecap” on the loan before signing, or the maximum interest rate you can be charged during the life of the loan.
- Getting a HELOC before refinancing. If you plan on refinancing the primary mortgage on your home in the near future, don’t take out a HELOC first. Many lenders use the loan-to-value ratio of the property in refinancing and will include both the primary mortgage and the HELOC in that determination. Some lenders may require you to pay off your HELOC or close it before you can refinance. Depending on the interest rate, a cash-out refinance may be a better option.
- Borrowing more money than is needed. If you have significant equity in your home, you may be tempted to borrow more than you actually need. Only apply for the amount of credit you need to cover your expenses or enough to protect you in an emergency. If you have a large amount of open credit, it can entice you to spend more than you can afford.
- Not shopping around for the best rates. Some people go straight to their banking institution to open a HELOC out of convenience. This can cost you big in interest charges as some lenders offer better HELOC rates and lower fees than others. Use the Home Equity Section of BankingMyWay.com to compare rates on home equity loans in your area. A little due diligence upfront can pay dividends.
- Only making interest payments for an extended time. Most HELOCs allow you to make minimum monthly payments of interest only. It’s okay to occasionally exercise that option when finances are tight, but you should not do it on a regular basis. If you only pay interest on your HELOC, you will not decrease the principal and you will have to continue paying indefinitely. The variable interest rates on the balance can cost a lot over time. The best way to us a HELOC is to pay off the balance as soon as possible to avoid high interest charges.
- Overlooking prepayment penalties. Don’t choose a HELOC that has a prepayment penalty if you plan on refinancing or selling your house with the next three to five years or so. A prepayment penalty charges you a fee for paying off the balance of the loan early. You should be able to find a HELOC without this feature or negotiate it out before signing.
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