There is the potential for a lot of excitement
and optimism to come with the application—and approval—of a home equity line of
credit, and sometimes, the immediately perceived benefits outweigh the risks.
So, when considering whether you want to apply for one, take a moment to review
the risks and compare options in order to find the best situation for you and
Is Home Equity and How Does it Work?
Home equity is the value that your house has
once its fair market value is assessed and compared with the remainder of what
you owe. As with any loan type, there’s a risk you won’t be able to pay it. One
of the biggest things to keep in mind with regard to home equity loan risks is
the fact that your house is on the line. Your home is used as collateral
whether you’re applying for a regular home loan or a HELOC (home equity line of
credit). While the two forms of loans vary to certain degrees, the risks are
mostly similar, and your house is weighted against the loan.
of Interest Rates Increasing and Bumping up Your Monthly Payments
This is a very real scenario. While during any
standard glance at the housing market and establishing where the prime rate is,
it’s important to remember that there are multiple things that could go awry
and put you in a massively uncomfortable position with your monthly payment.
After the Federal Reserve cut rates three times in 2019, they also indicated
there weren’t going to be any rate hikes coming up on the 2020 horizon. So it’s
safe to say that it’s among the best of times for people interested in taking
out home equity loans.
House Is On the Line
This reiteration is on purpose and deserves
its own subtitle. Your house is on the line, and there’s no reason to
jeopardize that. But there’s no reason to fear this fact either, especially if
you have decent credit and the amount you’re “taking out” against the equity
(or grown value) isn’t too extravagant. Still, it’s a primary factor to
consider when weighing the risks and benefits of home equity loans or lines of
Equity Can Rise and Fall
The best advice that goes along with this risk
is simple: don’t borrow more than you need to. Similar to the reestablishment
of rates, there can be changes in the market that upset the order to things
such as HELOCs and home equity loans. For instance, there were upsets in the
market with the 2008 housing bubble burst, and a lot of people found themselves
upside-down after the crash. Simply put, they owed more on their homes than
their homes were, at the time, valued. This is a real risk to consider too, as
you could end up owing more than the fair market value of your house.
Couple More Risks To Be Aware Of
addition to your monthly mortgage payment, you’ll have this one too
While the payment is reduced, it’s still an
additional payment on the property. In an ideal world, the equity would be used
to advance a long-standing goal or boost your business through investment or
increased reach. Regrettably, what sometimes happens is that instead of the
money being invested in and working for your business, you acquire even more
debt. There’s even the added risk of lowering your credit score by maxing out
the credit line.
Equity is technically an inexact number, and
although this is the case, it’s still an important notion. If you apply for any
other new loans, the overall loan amount is still added to the total borrowed
against the property. The more equity you keep available, the more options
you’ll continue to have available. If your loans against the equity max out,
then note that there won’t be as much wiggle room in terms of value when you
want to sell or refinance, and you may have to keep the property until you have
regrown or gained more equity in the property.
There’s an interest-only option for the first
10 years on a HELOC. During the repayment period in the first 10 years, there’s
no principal payment added to the monthly payment. Because there’s no
principle, it will need to be repaid during the following 10 years, unless
you’re attuned to this fact and consider the math. The interest-only payments
will seem lower and manageable, but once the principal is figuring into the
loan, the monthly repayment amount can be significantly higher.
During the draw period, where you’re able to
access and draw funds out of the account, it makes sense to keep track of how
much you’re taking out. Your best option is to make payments that cover both
interest and principal. Borrowers who only make minimum monthly payments are at
risk of never paying off their loans. It’s best to pay off the balance before
the 10-year period is over. A final note on the topic: a HELOC should never be
used to finance a lifestyle beyond your means.
Just as there are going to be various home equity options available to homeowners, there are going to be associated risks. If you’re a homeowner with equity in your home who wants to upgrade the kitchen or finance a child’s private school tuition, then take a look at home equity loans and lines and see where you can help along your project or goal. The experts at Rivermark Community Credit Union will be able to clarify any concerns and answer any questions.