HELOC dos and don'ts to know
Your home equity is a powerful financial tool. The average American homeowner has nearly $200,000 in tappable home equity that can come in handy in a seemingly endless number of circumstances. For example, you can use your equity to pay off debt, make necessary home repairs and cover the cost of emergency medical expenses.
One of the best ways to tap into your home's equity without making any changes to your existing mortgage is a home equity line of credit (HELOC). These lines of credit typically give you access to meaningful amounts of money. And since they're backed by the equity in your home, they usually come with competitive interest rates.
On the other hand, as with any financial tool, there are things you should and shouldn't do with HELOCs. After all, these loans can have a detrimental impact on your financial stability if you use them improperly.
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HELOC dos and don'ts to know
As mentioned above, HELOCs can be financial tools that help improve your financial stability, but they can also have a negative impact on it. That all depends on how you use these loans. Here are the dos and don'ts you need to know before you use a HELOC.
Do: Figure out how much money you actually need
When you use a HELOC to tap into your home equity, it's important that you only borrow the amount of money you need access to. After all, you'll have to pay the money back at some point, and the less you borrow, the lower your monthly payments are going to be when that time comes.
It's wise to start by assessing the expense you plan on using a HELOC to address. For example, if you need to repair your home's foundation, get a few quotes to determine how much money the foundation repair will cost. Keep in mind that quotes are often inaccurate. So, it's a good idea to borrow an additional 10% for construction projects. If you believe it will cost $25,000 to repair your foundation, you may want to borrow $27,500 to make sure you have the money to cover any additional costs.
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Don't: Borrow money you don't need
On the other hand, it's important not to borrow too much money when you take out a HELOC. "When it comes to HELOCs, you shouldn't apply for one unless you absolutely need the money," explains Mark Charnet, founder and CEO of American Prosperity Group in Sparta, New Jersey.
That may mean you borrow the money to pay off high interest rate credit card debt, you use it to cover unexpected medical expenses or you use it to pay for a wide range of other necessary expenses. However, you shouldn't borrow against your home equity simply for the sake of putting money in your pocket.
Do: Create a plan for paying your HELOC off
"If you haven't considered the additional time you will need to pay down or off a HELOC, then you should avoid it at all costs. Planning is crucial. If you don't plan for it, then it could be detrimental," explains Charnet.
Considering the fact that most HELOCs have variable interest rates, your plan should anticipate a possible rate increase. Charnet says, "you shouldn't apply for a HELOC if you cannot afford the payments, assuming rates will rise about 1%. But, if you can get a HELOC with a fixed interest rate for the life of the loan, then it could be beneficial."
It's also worth noting that today's interest rates are relatively high. So, variable rates may be a good idea as they give you the ability to take advantage of future rate declines.
Don't: Forget about your regular mortgage payments
It's important to keep in mind that your HELOC isn't a replacement for your current mortgage. You'll still need to make your regular mortgage payments alongside your monthly HELOC payments.
Do: Compare your options
Financial institutions are private companies that are free to charge whatever interest, closing costs and other fees they deem fit when they give you a loan. In fact, these are some of the most common ways that financial institutions compete for your business. So, it's a good idea to shop lenders before you take out a HELOC. Be sure to compare at least three leading options to ensure you're getting a competitive rate and fee schedule.
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The bottom line
A HELOC can help you cover a wide range of unexpected expenses. And, if used properly, it can help you achieve or maintain financial stability. On the other hand, using a HELOC improperly could come with disastrous consequences. Follow the dos and don'ts above to ensure you get the most out of your HELOC.
