Home equity lines of credit (HELOC) are a good option for individuals who would like to take out cash from the amount of equity they have acquired in their home. The revolving nature of this type of loan is good for borrowers with intermittent financial needs, especially when these needs may not be predictable.
However, this type of loan does come with some disadvantages that should never be overlooked. One of the main differences between a home equity line of credit and an adjustable rate mortgage (ARM) is the fact the interest owed on the loan is calculated daily. The reason why interest rates may change so frequently is because the loan amount may also change from one day to the next. This makes the monthly payments amounts much less stable than that of a traditional mortgage loan.
One of the primary disadvantages of a HELOC is the risk of defaulting on the loan because of rising interest rates, just like a credit card. All home equity lines of credit do have adjustable rates, but they seem to carry a much higher risk than that of a regular adjustable rate loan. Changes in the mortgage market can affect HELOC rates very quickly.
If interest rates just so happen to rise on June 30th, your HELOC payment may reflect the change as soon as July 1st. Some do come with guaranteed initial rates, but this is generally only for a very short amount of time. On the other hand, regular ARM loans usually have a fixed interest rate for 5-10 years.
Another big difference between HELOCs and regular ARM mortgages is the fact these loans do not have the same type of adjustment caps that ARMs have. Because of this the interest rates on a HELOC can rise dramatically if this is what the market demands. ARMs also have a much lower maximum interest rate than these loans, because ARMs usually have a limit of about five to six percent higher than the initial interest rate. On the other hand, HELOCs can rise much higher in a short period of time.
The fact that HELOC loans are very similar to credit cards can be considered an advantage or a disadvantage depending on which side of the fence you’re on. If you are a person with spending habits which have proven to be dangerous in the past, you should consider these types of loans dangerous.
Even more so and as the name suggests (Home Equity Line Of Credit), you are basically putting your home at risk and that definitely makes you vulnerable. If you do not manage to keep up with your monthly payments (and again, these will be on the high side with HELOC loans which are not exactly considered affordable) and you do not manage to reach an agreement with your lender, you will end up losing your home.
Despite these disadvantages, home equity lines of credit can be very useful to some borrowers. Just make sure you can handle the extra payments, and make yourself aware of all the risks associated with these lines of credit.