The One Thing Too Many People Get Wrong About HELOCs

If you've been thinking about taking out a HELOC, you're not alone. As of the third quarter of 2022, HELOC originations amounted to 405,646, according to data from TransUnion. And we could see that number grow this year as more and more homeowners seek to tap the equity they have in their homes before property values start to decline.

The upside of taking out a HELOC is that it can be fairly easy to qualify for one when the equity in your home is there. When you take out a personal loan, by contrast, your lender is apt to place a lot of emphasis on your credit score, since that type of loan is unsecured.

HELOCs are secured by the properties whose equity is being tapped. This isn't to say you'll qualify for a HELOC if your credit score is terrible. But a lender may be more forgiving if your credit score isn't the best.

But while HELOCs can be a convenient and seemingly affordable way to borrow money, there's a big risk involved in taking one out. And it's important to understand that risk before moving forward.

Don't assume your payments will remain affordable

Some people sign up for a HELOC and think they'll swing their payments just fine. But what you may not realize about taking out a HELOC is that these lines of credit generally come with variable interest rates. That means your debt has the potential to get more expensive over time if interest rates climb.

Existing HELOC borrowers face that danger right now. The Federal Reserve has been implementing interest rate hikes since early 2022 in an effort to slow the pace of inflation. That's made it more expensive to borrow money across the board, whether in the form of a personal loan, auto loan, or home equity loan.

Meanwhile, those who have HELOCs already may see the interest rate on their debt climb due to recent hikes. And if you sign a HELOC, you'll be taking a similar risk.

A fixed-rate loan may be a better choice

One benefit HELOCs have over home equity loans is that you get access to a line of credit you can tap at different intervals. When you sign a home equity loan, you're borrowing a lump sum of money at once.

But one major benefit of signing a home equity loan over a HELOC is that you'll lock in a fixed interest rate on the sum you borrow. That means you'll be looking at predictable payments as you work to shed that debt. With a HELOC, you don't get that same guarantee.

Remember, a HELOC that becomes more expensive over time may do more than just wreak havoc on your finances and budget. It might also put you at risk of losing your home.

If your payments get so expensive that you can't keep up with them, you might eventually lose your home if that's the only way for your HELOC lender to get repaid. That's clearly not a scenario you'd ever want. So while you may decide that borrowing against the equity you have in your home is your best option for accessing money, you may want to opt for a loan whose payments can't get more expensive over time.