6 Bad Reasons to Get a HELOC Loan

If you have had a first mortgage for a few years, you probably have built up some equity in your property. You may have decided to open up a home equity line or credit or HELOC. A HELOC is much like a credit card, but your limit is based upon the amount of equity that is in the home. Many lending institutions will give you a line of credit that is up to 80% of your equity. So, if you have a $200,000 house and have paid down $25,000, you could borrow maybe $50,000.

A HELOC can be a good choice in some situations. First, you can open it and not even use it; it can serve as an emergency fund. The debt can be tax deductible if you are using the money for home improvements. Also, you can pay for expensive items easily such as a home renovation or college tuition.

But there are many reasons to not get a HELOC, so think carefully before you decide to pull the trigger on this big financial decision:

#1 Missing Payments

Remember that you are putting your personal home on the line when you get a HELOC. If you do not make your payments on time, the lender can take your home from you. A HELOC is secured debt. It means that the debt is backed by your home. If you do not pay, you lose the collateral. If you are the sort of person who runs up debt and has trouble paying their mortgage on time, getting a loan that is secured by your home may not be the best choice.

#2 Questionable as an Emergency Fund

One of the problems with a HELOC as an emergency fund is that it is based upon your credit. Say you lose your job and miss a mortgage and car payment. Your bank could freeze your HELOC. Right when you need an emergency fund, that HELOC might not be there.

#3 It Isn't Money for Free

Keep in mind that your HELOC is not free money. It is really just more debt. It is simply allowing you to access some of the equity in your property to spend as you wish. You should be careful how you spend that money. It only should be used for legitimate purposes, such as paying for home renovations or a college education. Some people may use it to pay off credit card debt, but this can be dangerous if you only run up more debt again on the credit cards.

#4 Rates Vary

HELOC rates usually start with a low teaser rate for the first six months or year. After that, the rates can fluctuate. In our generally rising interest rate market in 2019, HELOC rates will probably be on the rise overall. So, you could wind up paying a higher rate in five years than you expected.

Additionally, a HELOC is an interest only loan for the draw period of 5 or 10 years. After that, you must pay both principal and interest. So, your payment will rise substantially at the conclusion of the draw period. It is at this point that some borrowers get into trouble and can no longer make payments.

#5 Refinance Problems

If you ever want to refinance your first mortgage, you may have to pay off the HELOC first. Some lenders will not let you do a refinance without paying off the second mortgage. If you want to refinance your first mortgage into a lower rate in the next few years, you probably want to hold off on the HELOC.

#6 Paying for Things That Don't Pay You Back

It is nearly always a mistake to use your home equity to pay for things that do not appreciate in value. You generally should not buy a car with a HELOC; a car nearly always depreciates substantially as it ages. Nor should you use home equity to go on vacations, buy boats or other extravagances. The best use of a HELOC is to use it for things that bring you more money, such as a home renovation, investment property, or possibly a college education.