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This Popular Borrowing Option Is More Dangerous Than You Might Think

By Maurie Backman - Dec 8, 2020 at 8:00AM

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Before you borrow against your home, consider the consequences at hand.

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You may reach a point in your life when you need to borrow money, whether to cover unplanned medical expenses, repair a car, or ride out a period of unemployment. And when it comes to borrowing, you have choices. You can apply for a personal loan. Or, you could charge those expenses on a credit card with a 0% introductory APR (not highly recommended, but an option nonetheless).

But if you own a home, you may be able to borrow against it. In fact, many homeowners are fans of the home equity line of credit, or HELOC, because it's flexible and relatively easy to access. 

With a HELOC, you don't borrow a lump sum and immediately start paying it back. Rather, you get access to a line of credit you can draw from as needed. Your draw period -- the time you can take out money on your HELOC -- will be limited to a certain number of years (usually five to 10). But that still gives you the option to, say, open a $10,000 HELOC tomorrow, take out $2,000 this year to cover an expense, and let the remaining $8,000 sit. You might pay some of that money back, or go on to borrow another, say, $3,000 or more in a few years. 

HELOCs are also pretty easy to qualify for because your home is used as collateral. Personal loans, in contrast, aren't secured by a specific asset. As such, you don't need the best credit score in the world to get one. Your HELOC lender will largely base the decision on the value of your home and the amount of equity you have in it (meaning, the percentage of your home you own outright). If you have 20% equity in your home or more, you'll generally qualify for a HELOC. For example, you should be eligible if your home is worth $200,000 and your mortgage balance doesn't exceed $160,000.

According to a new research report by The Ascent, the average U.S. HELOC value was $49,929 in 2019. But while a HELOC may seem like a good way to borrow, there's one big danger you should know about.

The downside of getting a HELOC

You may have heard the term "second mortgage" tossed around, and a HELOC is an example of one. A second mortgage is basically an additional lien placed against your home. It gives a lender the right to that property should you fail to stick to the terms of your borrowing agreement. 

When you get a HELOC, your original mortgage lender has a primary lien on your home. If you don't pay your regular mortgage, that lender is first in line to go after your property. But your HELOC lender is second in line. So if you manage to keep making your mortgage payments but fall behind on your HELOC payments, you could still end up losing your home. 

In this regard, personal loans are actually a safer borrowing choice. Defaulting on a personal loan could wreck your credit, but your lender can't take a physical asset away from you. With a HELOC, your lender can force the sale of your home to get its money back. 

Of course, the way to avoid that fate is to not fall behind on your HELOC payments. But sometimes, circumstances change, and you may find yourself struggling to keep up with those payments. And losing your home is a serious consequence you need to be aware of when you take out a HELOC.

Don't go overboard with your HELOC

Now, this isn't to say that a HELOC is always a bad idea. In some cases, it can be an affordable, easy way to borrow. The point, rather, is to understand what could happen if you were to fall behind with your payments.

Also, if you're going to take out a HELOC, don't go overboard on the line of credit you secure. That could open the door to more spending. If you have a sudden $8,000 expense you need to cover, you might apply for a $10,000 HELOC to give yourself some wiggle room. But don't rush to take out a $30,000 HELOC. Borrowing too much from a HELOC could compromise not only your financial security but also the roof over your head.

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