Why Taking Out a HELOC Could Be Dangerous This Year

You may want to go another route.

These days, homeowners across the U.S. are sitting on lots of equity. That's because home values have risen substantially over the past year, and that gives property owners the option to borrow against their homes. 

If you have a need for money, you may be thinking of taking out a home equity line of credit, or HELOC. And there are benefits to going this route.

With a HELOC, you're not limited to a single lump sum you can borrow. Rather, you get access to a line of credit you can draw from as needed over an extended period of time -- sometimes up to 10 years. 

Plus, HELOCs are fairly easy to qualify for because they're secured by the equity you have in your home. When you take out an unsecured loan, like a personal loan, your lender can really only rely on your credit score and history when determining whether to loan you money. 

But while HELOCs certainly have their advantages, there's one major drawback to taking out a HELOC. And it could come back to haunt you this year in particular.

Rising rates spell trouble for HELOCs

While HELOCs may offer a lot of flexibility, one thing they don't tend to offer are fixed interest rates on the sum you borrow. Rather, HELOC interest tends to be variable, and that can make your monthly payments change over time. 

If your payments rise a lot, they could become difficult to keep up with. And if you fall behind on your HELOC payments, you risk consequences such as credit score damage and the possibility of losing your home. 

Meanwhile, the Federal Reserve is moving forward with a series of planned interest rate hikes in an effort to slow the rate of inflation. And that could make any sort of loan or credit line with a variable interest rate become more expensive in the coming months. 

That's why you really should proceed with caution when taking out a HELOC. You might like the idea of being able to tap a credit line at different points in time, whereas with a home equity or personal loan, you're borrowing a lump sum. But because interest rates are likely to keep climbing, taking out a HELOC could mean facing very expensive payments down the line.

A better way to borrow right now

If you need to borrow money, it could really pay to lock in a loan with a fixed interest rate. If your credit score is in good shape, a personal loan could be a smart choice. But if your credit score isn't the best, then a home equity loan could result in a lower interest rate, since your lender might overlook less-than-stellar credit (at least to some degree) if you have a lot of equity in your property. 

Of course, no matter what borrowing route you take, it's a good idea to keep that sum to a minimum. And that's another danger of HELOCs. While they offer flexibility, it can be tempting to tap a HELOC if that credit line is there. But the ease at which you get access to that money could drive you to borrow for the wrong reasons. And so between that and the potential for higher interest rates, it could really pay to steer clear of a HELOC in the near term.