Most of us know that a home equity line of credit, popularly known as HELOC is a flexible way to obtain money. But, all these claims are effective only when you know how you can manage your HELOC in a prudent way. In case, you falter, this form of insurance can become very expensive and lead you to financial trouble.
Rising Interest Rates Can Increase Monthly Payments and Total Borrowing Costs:
In case of home equity line of credit, the rate of interest charged is variable. It is usually dependant on the FED funds rate in addition to a certain margin of profit decided by the lender. So if the interest rates go up, your monthly interest rates will automatically shoot up. There is no definite way by which you can predict when the percentage will increase and what might be the increase rate.
If the rate is too high, you will be unable to make the monthly payments. And when you falter, you get behind the payment schedule which can lower the credit score and lead to an increase in the amount of interest that you need to pay.
Try to find out about the maximum interest rate so as to have a clear idea of where this direct insurance might lead to. This is because higher interest rates also affect your total borrowing costs. When you have higher amounts to pay, it means that your spending power automatically gets decreased.
One way to fight this scenario is to opt for a home equity loan with a fixed interest rate rather than HELOC or you can opt for the fixed rate option that you get with HELOC. However, keep one factor in mind. When you are opting for a fixed interest rate you are opting for a higher interest rate of payment. Are you willing to take the risk?
Fluctuating Monthly Payments Can Cause Financial Instability
When you are opting for a HELOC, you are opting for an adjustable rate mortgage i.e. in other words your monthly payment structure can change significantly because the interest rates are bound to change. It might get difficult to plan for the future and save anything for your retirement.
There are many investors who are willing to take on this risk, especially when the rate of interest charged is low or when they know they can afford higher payment structure.
Interest-Only Payments Can Come Back to Haunt You
There are some varieties of HELOC’s that allows the user to make payments only on the amount borrowed, especially during the first few years of the loan tenure. This is great especially for short term aspects, as one can borrow a huge amount of money.
However, in the long run, it is not a feasible direct insurance option as you will end up paying more both as part of monthly payments as well as the amount that you need to clear off at the end of the loan tenure. If you do not plan properly, you will land in a huge financial soup.