Should You Get a HELOC?

Balances on home equity lines of credit (HELOC) have increased 20% since the end of 2021.

That has me concerned.

Sure, I understand the appeal of HELOCs in today’s market. Rising home values can mean the value of your home now far exceeds any remaining mortgage balance, and you want to tap some of that home equity to cover other expenses. Meanwhile, with mortgage rates having increased a lot over the past two years, it makes no sense to refinance your current mortgage if the new mortgage will carry a much higher interest rate.

I get that given all of that, a HELOC seems like a fine way to convert some of your home equity into money you can use today. But please hear me out: HELOCs can in fact be risky.

If you are considering a HELOC, or have recently opened a HELOC, I want you to make smart choices. Here’s what you need to know about HELOCs:

• Your home is collateral for a HELOC. If you ever fall behind in payments there’s a risk you might lose the house.
• Lenders can suspend or reduce your line of credit. In a severe recession where home prices decline, and households are financially squeezed, lenders can reduce the limit on a line of credit, or they can close it entirely. I sure hope we don’t run into this scenario, but that’s what happened during the financial crisis.
• Most lines of credit have an adjustable rate. The typical structure of a HELOC is that you can draw on your line of credit for a period of 10 years. During that time you can repay any money you have drawn, or you can opt to just pay the interest on borrowed amount. After the 10-year draw period, you must repay the balance (typically within 10 years). The interest rate during the draw and repayment period is usually adjustable. If rates move higher, your cost of repayment will be higher.

Okay, now that you understand some of the risks, let’s chat about how to be smart about deciding if you need a HELOC, and how to use one if you go that route.

For starters, you are never ever to use a HELOC to pay for a want. With your home as the collateral, there is just no argument for borrowing—and owing interest—on a loan for a vacation or a nicer-than-needed car, or some home upgrade that is nice to have but not necessary.

If you are opening a HELOC as some “what if” insurance for a rainy day (an illness, a layoff, etc.), remember what I just explained: lenders can change the terms of HELOCs, such as freezing access, at any time. That makes a HELOC a risky way to “plan” for emergencies. The right way to protect yourself and your loved ones is to build up at least a year of living expenses in a standard savings account.

If you do need to tap a HELOC for a need, you should think through how long it may take you to repay the money. If you anticipate that you will be able to pay off a balance in a year or two (or faster), a HELOC with an adjustable rate can be okay. But if you anticipate needing longer, it may make more sense to seek out a fixed-rate HELOC. While the interest rate will be higher than the current rate for an ARM, the fixed rate is protection for you during the years you will be repaying the money. With an ARM, you would have the risk of rates moving higher during the time when you are repaying the money.