DEBT | NOV 5, 2021

Return of the Harrowing HELOCs

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Jim Henry

There haven’t been many bright spots in the COVID pandemic, but banks tightening requirements for home equity lines of credit may have been one of them.

When the pandemic hit in late 2019, many of the nation’s leading lenders began scaling back HELOCs. That was then. Now, plenty of lenders are willing to make them and their cousin, the home equity loan. The names are similar and both tap into the equity of your home, using the house as collateral. There are at least two significant differences, however.

First, a home equity loan sets a fixed amount to be borrowed all at once, with fixed monthly payments for a determined amount of time, maybe up to 10 years.

A home equity line of credit, or HELOC, is more flexible. It’s a revolving type of account that sets a maximum amount to be borrowed, but you’re able to draw on that as needed and your monthly payments are determined by how much you’ve borrowed. The more you borrow, the higher your monthly payments.

Second, while home equity loans have a fixed interest rate and you know how much the loan will cost you, a HELOC will have a variable interest rate, which might be very low in the beginning to make the loan seem more attractive. Also, rates are very low right now. They can only go up.

Why are these loans making a comeback? First, many signs indicate the economy continues to recover slowly, with some 10,000,000 unfilled jobs. People who want to work can work.

Plus, with home values sky high these days, total equity in American homes is the highest ever recorded, well above $7 trillion. That’s a lot of money to back these loans and lenders feel secure about making them.

Borrowers must be aware of the dangers involved with either of these loans. If you’re taking out one to pay off credit cards, for example, you’re exchanging unsecured debt for secured debt. Your home is now collateral for the loan and you can lose it if you’re not able to make the payments, just as you would with your mortgage.

These loans also often come with high origination and maintenance fees. They’re often what are called “demand notes.” That means the lender can call, or demand full repayment of the loan under certain circumstances, so check the fine print.

Why would a lender do that? There’s nothing to prevent lenders from checking your credit after a loan is made. They might do that if they’re thinking about offering to lend you even more, for example.

If they see that you’re making late payments somewhere else, it could trigger a demand for the loan to be repaid.

Is it always unwise to take out a home equity loan? No, because there may be circumstances where a financial calamity overwhelms your emergency fund and you really have no choice but to tap into your home’s equity.

An example might be significant damage to your home not covered by your insurance. Those events are rare, but they do happen.

By far the most legitimate reason to take out a home equity loan, not a HELOC, is to make repairs or improvements to your house and then only if the payments are well within your budget and you pay it off as quickly as possible.

So home equity loan, maybe sometimes. HELOC, never.

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