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3 Dos and 1 Don’t Before Taking Out a HELOC

As a homeowner, you may be looking at ways to borrow against your home equity. Home equity can prove itself useful through a regular home equity loan or a Home Equity Line of Credit (HELOC for short). A HELOC can allow you to access the funds at low interest rates compared to other loan options if you’re considering  the idea of renovating your kitchen, paying off an ongoing expense, or need a financial safety net

Before borrowing money, it’s always good to have a fully informed understanding of how it works. Below are some simple Dos and Don’ts to know if considering a HELOC. Making informed financial decisions are a lot better than making undisciplined, uninformed ones that could wreck your financial standing in the future.

What Is A HELOC?

A Home Equity Line of Credit (HELOC) is defined as a revolving line of credit that is linked to your home equity. You can be approved for a maximum borrowing limit, allowing you to withdraw funds for a draw period. Depending on the lender, your draw period can range anywhere from 5 to 10 years. During the period, you only pay interest. After the draw period expires, it is soon replaced by a repayment period where you then pay the principal and interest. 

HELOCs for the most part can be a useful borrowing tool. However, it is essential that you plan ahead of time to determine if it may be the best option for your financial needs. 

Do #1: Know How Much You Can Actually Afford To Borrow

While flexibility is one of the biggest advantages of HELOCs, you still need to budget carefully. Sure, getting approved for a $70,000 HELOC is good. But you are not obligated to use all of it. You do need to evaluate your income, expenses, and current debts before deciding how much you wish to borrow. 

It’s also a good idea to take note of the variable interest rates. Rates that change over time could increase your monthly payments. For this reason, be sure to think long-term and consider what your finances may look like as soon as you enter the repayment period and have to pay the principal along with the interest. Your repayment strategy has to be clear so you know what to borrow what you need knowing you can easily pay it off.

Do #2: Use the HELOC for Smart Investments

A HELOC can be used for numerous reasons. They are often considered as options for funding home improvement plans, paying off debt, or paying on tuition among other things. In other words, you should use the funds that can help improve your long-term financial picture. You could use the HELOC as an emergency backup fund, under the condition that you do not treat it like it’s free money (remember, you have to pay it back after the draw period ends). 

Not only that, your home is being used as collateral. It should give you one more motivational reason why you should keep HELOC funds to spend on something that is appreciating or income-generating investments as opposed to “short term wants”. Meaning remodeling your basement and using HELOC funds is the better financial decision as opposed to taking a vacation to somewhere tropical. Thus, you should have a good reason why you want to apply for a HELOC.

Do #3: Know The Terms Before Your Sign

HELOCs are not all the same. For this reason, you’ll want to look at the terms and fine print before you put the pen on the dotted line and sign. You’ll want to be aware of certain things like the interest rates, fees, repayment structure, and other items of relevance. More importantly, you’ll also want to ask questions such as:

  • What is the length of the draw period?
  • Are there any annual fees, closing costs, or early termination fees?
  • How does repayment work after the draw period expires?

HELOCs do have variable rates that can cause your payments to increase if these rates rise. In addition, the rates are low from the start but can lead to an unexpected increase over time. Stay ahead of the curve by monitoring the interest rate over time while also planning ahead for any payments you intend to make. Again, you are paying only interest during the draw period (and the principal on top of that after the draw period ends).

Don’t: Treat Your HELOC Like a Credit Card

This critical mistake is something that a homeowner can make. A HELOC does offer revolving credit that is akin to a credit card. What you might not realize is that the stakes are much higher than using a standard credit card for purchases. Once again, your house is collateral and recklessly using a HELOC can jeopardize home ownership. It is highly recommended that you avoid impulse spending or using it as a source of income.

Keep in mind that although you are paying on the interest only during the draw period, the balance does not go down. You could consider paying on the principle early. The sooner you pay down the principal, along with any interest, the less of a financial shock you can face when the repayment period begins.

Final Thoughts

A HELOC can be beneficial if used properly. It can be the best financial tool to have for whenever you need to make smart investments that can lay the groundwork for a more solid financial future. Before considering a HELOC, make sure you make plans ahead of time to determine if tapping into your home equity is the right move. Use the funds wisely and as intended, make the necessary payments, and have peace of mind knowing that you are able to take control of your financial situation.

Our team can help you understand your options and determine if refinancing is the right move for you.

Schedule a Consultation or Start Your Application Online

The Harvard State Bank is here to help make homeownership a seamless process. Whether you’re a first-time homebuyer or looking to refinance, we’ll help you find the loan that fits your needs. Our local specialists and lending options ensure you have the expert support you need to realize your dreams.

Begin your home loan application online , or speak with one of our mortgage lenders at 815-943-4400 for guidance every step of the way.