Extreme borrowing was one of the biggest culprits in the last housing crisis. To avoid those dangers, here are seven tips on borrowing through a home equity line of credit.
Housing prices have recovered since the 2008 housing crisis, and, the rise in home values seems to also be encouraging borrowing, including home equity lines of credit (HELOCs).
A HELOC is a convenient way homeowners can use their home’s equity to renovate their home, make a large purchase or fund other needs. But to make a HELOC work for you, you need to know how it can affect your financial situation.
Here are seven lessons for homeowners to learn from the 2008 crisis.
1 Take advantage of low rates on HELOCs — responsibly.
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In the last housing crisis, extreme borrowing was named one of the biggest culprits. And, low interest rates along with moderate inflation is one of the factors that often leads to strong growth rates in borrowing.
But although borrowing has increased recently, borrowers now have to meet strict criteria to get approved for a HELOC. In other words, borrowing rates haven’t gotten out of control like they did during the last housing bubble. And, it seems likely that increased borrowing and credit limits are signs that homeowners are carefully planning for the future rather than speculating on rising home values and prices.
2 Make sure you can afford to pay back your HELOC.
Home prices and values are increasing across the nation. In fact, many cities are seeing home prices skyrocket to levels not seen since the housing bubble. Incomes are rising as well.
But to avoid déjà vu and a repeat of the 2008 housing crisis, make sure you can really afford to pay back your HELOC when the time comes.
“Having a solid home with good value and a steady job is leading consumers who have been in their house long enough and need renovations to consider HELOCs,” said Mike Kinane, senior vice president of home equity at TD Bank.
3 Figure out what you’re going to do after your HELOC resets.
When a HELOC resets, its draw period — which is the period of time you can borrow on your line of credit and pay only the interest — is ending. The repayment period then begins, and you start paying the fully amortized payment, which is interest plus principal.
A HELOC reset can be a major financial challenge to homeowners. But, a homeowner has options, including refinancing into a new HELOC, or allowing it to reset into an amortizing payment, or even paying it off. With home prices on the rise across the U.S., homeowners have the opportunity to use their home’s equity in a very strategic manner. But using your home equity in a smart way requires careful planning.
4 Review lender information about HELOC contracts.
A survey by TD Bank found 27 percent of respondents don’t know when their HELOC draw period ends, which could be devastating if they haven’t financially prepared themselves for the repayment period.
The best way to keep up on the financial details and prevent something going wrong with your home or home loan is to pay attention to your lender. Your bank will send you reminders before your draw period ends, and you also have the option to call in, go online or visit in person if you need help.
5 Know what impact your HELOC’s draw period expiration will have on your monthly payments.
Understanding a HELOC’s financial impact means working closely with your lender, who can tell you how the reset will affect your financial situation.
6 Consider getting a fixed-rate HELOC.
HELOC rates are based on prime rates, which are subject to changes in the federal funds rates. A change in the Fed rate means HELOC rates are affected as well. So, a rate hike would mean increased monthly payments for HELOC borrowers.
“When rates rise up, that may accelerate customers thinking about what they should do with the debt (i.e., refinance or pay it off),” Kinane said.
For this reason, stay in contact with your lender and research your HELOC options. For example, the TD Bank HELOC offers a fixed-rate HELOC option for those borrowers that don’t have the appetite to manage future rate hikes.
7 Protect your home’s value by using a HELOC for renovations.
Sure, home values and prices have been steadily increasing across most of the nation since 2011. But we learned in 2008 that home values can decrease, and homeowners need to be prepared.
Home renovations are one of the most popular uses of HELOCs, with 38 percent of TD Bank survey respondents using them for this purpose.
Home renovations can increase your home’s value, and thus your home equity as well. Plus, with guidance from your lender, you can then get flexible, convenient refinancing when your HELOC resets.