A Home Equity Line of Credit or a HELOC, popularly known for its convenience, is a type of credit that lets you borrow money when you need it.
Akin to a credit card and a known low-cost loan which has a variable interest rate that tends to be lower than standard APRs, HELOCs will only let you borrow the actual amount of money you need.
The pros and cons of HELOCs are rampant on the internet thus, in this article, we will focus on the cons of HELOCs.
Where NOT to Spend a Home Equity Line of Credit
As humans with natural wants and needs, we tend to prioritize immediate wants over long-term necessities. Some however are immediate necessities but prove to be over budget. Often, the question is: is this the right loan or credit for it?
1. Pay for a Vacation
Vacations are an integral part of a person’s well-being, however, using your home equity to relax will definitely lead to the opposite of relaxation as HELOCs tend to be unstable when it comes to the monthly payment due to its floating APR. Thus, vacations are a no for this type of home equity loan. Maybe try a personal loan for that dream vacation.
2. Buy a Car
A car is both a necessity and an asset. A depreciating asset, yes, as cars depreciate the moment you step foot on that gas. But overall a typically good investment and a sound move for the future but financial institutions offer car loans for a reason: to buy a car.
3. Pay Off Credit Card Debt
Consolidating debt is a smart strategy considering of course that your strategy meets your monthly income. However, getting behind on HELOCs will also hurt your credit score. Is paying off your credit card debt worth risking unstable monthly interest rates? Didn’t think so.
4. Pay for College
Getting that college degree will definitely help you secure your future even further, but college tuitions are far from chump change. Using your HELOC to pay for college is not chump change in the long run either. If you cannot get that scholarship, might as well apply for that student loan. Better check that pros and cons.
5. Invest in Real Estates
Investing is great, especially on physical assets. Real estates are a great way of increasing your funding and boosting your financial stature. As long as you can afford it though. If you are well versed and adept in finance, go get that investment. Financial institutions offer home loans, so you do not have to risk your hard-earned bucks for that unstable monthly interest.
Disadvantages of Home Equity Line of Credit
Here is the thing, a HELOC may seem to be a good way to consolidate your debts and liabilities and it is if you’re well-disciplined and financially capable.
HELOCs work like a credit card. Get what you want when you need it and pay for it at a later date. However, unlike credit cards, HELOCs have variable interest rates which make it hard for people who do not include allowances in their monthly budget.
Loans with variable interest rates or “floating” interest rates or “adjustable” interest rates are highly unstable due to its unpredictability.
In this article, seven main disadvantages have been identified as the main crooks that make home equity loans less appealing and less feasible for newbies especially if you are looking to consolidate debt: It uses your home as collateral, unstable interest rates, uncapped variability, budget instability, difficult to manage, higher repayments, and again, its unpredictability.
1. Using Home as a Collateral
Many view HELOC as a main stream of funds for home improvements and they are not wrong. It is a good way to fund home improvements as it looks like the house pays for itself.
The thing is, you should avoid using your home as collateral for things you can apply specific loans for, or better yet, save up for that dream whatever!
2. Adjustable Interest Rate
This disadvantage, as we see it, is the root of the HELOC’s disadvantage. An adjustable interest rate is a fluctuating interest rate that can and will lead to budget instability.
Variable rates are a sound option for short-term loans as you will be able to enjoy that low interest rate since it fluctuates over time but for long-term loan commitments and for newbies especially, any financial instability is a hindrance to financial security.
3. Uncapped Variability
The uncapped variability of HELOC’s annual percentage rate make it daunting especially for long-term equity loans. As its uncapped annual percentage rates may escalate over time, it may prove difficult to pay the principal loan or even to look at monthly as time passes.
4. Budget Instability
Its variable rates, like we mentioned above, leads to financial instability. Measly increases in its uncapped annual percentage rate may be a nudge to your monthly payments.
That monthly nudge may push your budget to its limits which would get you behind on your other financial responsibilities that are at fixed rate. Which in turn will hurt your credit score. Which will definitely lead to further financial constraints.
5. Difficult to Manage
To an untrained eye, every finance-related commitment such as equity loans and other credit are difficult to manage. A HELOC however is a whole other level of difficulty due to its easy-going nature and enticing low-interest rate.
It may seem to help you get lower monthly payments but due to its variability, this equity loan will most probably give you a fixed rate for your headache.
6. Higher Repayments
An unconstrained stream of fund with flexible repayment schedules will often lead to overspending. Which of course will lead to higher repayments, one that is way past your expectations. Never sacrifice a quick ease in your monthly payment.
Again, due to its low-interest rate environment, people are magnetized by HELOCs. However, the unpredictable nature of this type of credit might hurt your credit score in the long run as you get behind on payments due to variable interest rate.
Its uncapped adjustable rates have no tell-tale signs of when it will increase nor decrease. Its unpredictability will lead to your financial instability.
Alternatives to Home Equity Line of Credit
If you really need that funding for a specific reason, apply for a loan that specifically attends to your needs. In case HELOC fits the bill, might as well try for these few alternatives:
1. Home Equity Loan
Instead of using your home equity for HELOCs, might as well get a home equity loan. Financial institutions that offer home equity loans will lend you a lump sum at higher BUT fixed interest rate. Stability is a pro without a con in itself. So you should rather aim for that home equity loan.
2. Cash out Refinance
Refinancing is a go-to move in real estate. A cash-out refinance is like renegotiating your previous mortgage. Refinances are often more favorable for the borrower as renegotiations can lower your monthly payments as well as your interest rate.
Even your time table can be adjusted. Cash-out refinance is a sound option for lowering your monthly financial responsibilities.
3. Personal Loan
A personal loan is money borrowed from a lender to be used for the borrowers own discretion. A personal loan however is based on your credit score, credit history, and income so it might be difficult to apply to for someone who is financially unstable with a bad credit. If you can apply for a personal loan, go for it as it does not require collateral. Do not forget however, to borrow only what you need as overfunding may often lead to overspending. Personal loans typically offer fixed interest rates so instability and unpredictability of payments may not be a problem for this type of loan.
So, were you able to understand the difficulty level of HELOC? The bottom thing is, whatever financing you may need, in whatever aspect it may come, stability and predictability is your ally.
Do not settle for something due to its lowball offers, focus on what you need, research well on the loan or type of credit you are planning to apply for, always include time as a factor, and of course, compute everything up to the last digit.