2 Sneaky HELOC Pitfalls You Should Know About

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Before you take out a home equity line of credit, make sure you understand the drawbacks involved.

If you need money for any purpose, whether it's to pay off credit card debt or finance a home renovation project, you might consider borrowing against your home. These days, home values are up on a national scale, so borrowers have more options for tapping their home equity.

Equity refers to the portion of your home that you own outright. Most people who buy a home finance it via a mortgage and won't own it outright until that loan is paid off. If you have $200,000 left on your mortgage but the current market value of your home is $300,000, that means you have $100,000 in equity. And you can borrow against that equity in one of two ways:

With a home equity loan, you borrow a lump sum of money and pay it off over time. With a HELOC, you get access to a line of credit and can take withdrawals from it at different times.

Usually, you'll get a 5- or 10-year window to access your HELOC. Once you take withdrawals against it, you only have to pay back the sum you actually borrow. Or, to put it another way, if you qualify for a $20,000 HELOC but only end up withdrawing $5,000 from it, you'll only repay that $5,000, and you won't accrue interest on the remaining $15,000 balance.

The great thing about HELOCs is that they can be very flexible. If you know you have a need to borrow money -- say, to pay for home renovations -- but you're not sure what your total costs will amount to, you can always err on the side of getting a larger HELOC and only borrowing the sum you need. But before you sign up for a HELOC, make sure you're aware of these key pitfalls.

1. Your interest rate will generally be variable

When you take out a home equity loan, the interest rate on it will be fixed, so your monthly payments for that loan will be nice and predictable. HELOCs, however, tend to come with variable interest rates, and that means yours can climb over time. The result? Higher monthly payments that mess up your budget.

2. You may be tempted to keep taking withdrawals

The fact that HELOCs are so flexible isn't always a good thing because you may be tempted to keep tapping that line of credit to pay for things that aren't worth borrowing for. It's one thing to take out a HELOC to finance home improvements that could increase the value of your property. It's another thing to tap a HELOC to take a vacation or buy a new TV.

Once you have your HELOC in place, you may be inclined to borrow against it if there are funds left over that you haven't accessed. But that could open the door to borrowing for the wrong reasons.

Be careful when getting a HELOC

HELOCs, like home equity loans, are fairly easy to qualify for as long as you have enough equity in your home. But remember, both home equity loans and HELOCs are secured loans. Specifically, your home is used as collateral for both. If you fall behind on your HELOC payments, you could risk losing your home. So exercise caution and restraint when applying for a HELOC.

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