Set yourself up for financial success by considering (and avoiding) these top HELOC mistakes.
Choosing to use a home equity line of credit (HELOC) is a big commitment and not something to take advantage of just because there’s money available. For the right candidate, though, it can relieve financial stress and set you on a positive path.
First things first: Familiarize yourself with the pros and cons of a HELOC. Once you’ve considered other options, such as a home equity agreement (HEA) or refinancing, you can feel even better about your decision by knowing how to avoid HELOC mistakes. We spoke with three mortgage experts to narrow down the most common mistakes you can make when looking to use a HELOC.
1. Not Getting a Full Appraisal Done
Once you apply for a HELOC, the lender will order a home appraisal to assess how much equity is in your home. The loan-to-value (LTV) ratio will determine that amount and, ultimately, how much you’re able to borrow. There are different types of HELOC appraisals, ranging from desktop appraisals, where no one actually comes to your home, to a full appraisal, where the exterior and interior of your home are evaluated for the structure’s integrity, as well as its major systems like the water system, electrical system and heating, ventilation and air conditioning (HVAC).
“Banks or credit unions will often do a drive-by or desktop appraisal, which will be more conservative, as they haven't seen the inside of the house,” says Ryan Dossey, cofounder of SoldFast, a real estate brokerage/home-buying franchise. “It's a good idea to request a full appraisal and provide the appraiser with supporting documentation to help their property appraise for the maximum value. If your home is nice or recently remodeled, provide appraisers with a scope of work and receipts to justify a premium value.”
2. Maxing Out the Credit Line
Once you find out the amount of your HELOC, it can be tempting to borrow it all. After all, it’s there for you to use, right?
“This is a big danger to your credit score,” says Corey Vandenberg, mortgage loan officer at Lake State Mortgage. “A line of credit is essentially reported like a credit card, so the balance vs. the credit limit matters to your credit score. A maxed-out line of credit will drop your credit score both for that line of credit and for your credit cards combined, especially since the line of credit is likely the largest ‘credit card’ that you have.”
It’s best to keep your HELOC usage at 30% or less, according to Vandenberg. So, if your HELOC is for $100,000, it’s ideal to only use $30,000 (or less) at a time.
3. Paying the Interest-Only Payment
A HELOC has two periods: the draw period, when you can take money out of your HELOC and the repayment period, when you start paying the interest and the principal back. Some HELOCs are interest-only, which means you only pay the interest during the draw period, which can last five to 15 years. So, your cozy low monthly payment will shoot up considerably once the draw period is over. If you have poor financial discipline or uncertain income, an interest-only HELOC is not the way to go. But even if you’re very disciplined and have a stable career, it might not be the best route for your long-term financial health.
“Unfortunately, we all must face the reality that most of us pay the minimum payments, not the most that we can,” says Vandenberg. “In my 24 years of doing these, I have seen time and again people say that they will pay down or off the line of credit in the next 10 years and instead, they make the interest-only payment for 10 years and return to get a new line of credit with the same or higher balance, in other words, they never pay it down or off.”
4. Assuming the Rate Will Be Consistent
Most HELOCs have a variable interest rate, which means that the interest rate will change based on market conditions and the federal funds rate.
“That means the rate – and payment – can change throughout the loan term. A homeowner must be able to handle this variability,” says Kyle Enright, president of lending at Achieve, a digital personal finance company.
Fixed-rate HELOCs allow you to lock in an interest rate for a portion or all of your HELOC so market factors do not impact you. You’ll know how much you’re expected to pay back each month and can plan accordingly.
5. Missing Payments
Of course, you don’t want to skimp out on paying back any sort of loan. However, with a HELOC, your home’s extremely important on the line.
“HELOCs are secured loans, meaning the home serves as collateral. If the homeowner missed payments for any reason, they may run the risk of foreclosure and losing their home,” says Enright.
Even if you’ve paid your mortgage on time every single month, defaulting on your HELOC could result in saying goodbye to the very thing that got you the loan in the first place. That’s why you must plan for fluctuating interest rates and feel confident you can cover it if and when it happens.
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Benzinga reaches about 25 million readers a month, arming them with insight on financial markets, corporate and economic data and actionable ideas. We take pride in informing people of all different financial backgrounds how to move forward in their situations positively. Caitlyn Fitzpatrick, the author of this piece, has been an editor and writer since 2014. She stepped into the commerce journalism world in 2017 and loves guiding people on making smart purchases.
For this story, we spoke with Ryan Dossey, cofounder of SoldFast, a real estate brokerage/home-buying franchise, Corey Vandenberg, mortgage loan officer at Lake State Mortgage and Kyle Enright, president of lending at Achieve, a digital personal finance company. They spoke about the top HELOC mistakes they’ve seen in their careers.
FAQ
What disqualifies you from HELOC?
One HELOC requirement is having a high enough credit score. That number, however, differs between HELOC lenders. Typically, you’ll need a credit score of at least 620, but some lenders require 700.
“You can be disqualified from a HELOC if you’ve purchased [a home] recently or have a higher debt-to-income (DTI),” explains Dossey. “Some programs also require that you’ve owned the property for six to 12+ months.”
How much income do I need for a HELOC?
There isn’t a specific number, as it’s more about how much you make and your expenses.
“Lenders consider a borrower’s debt-to-income ratio. It is calculated by dividing a borrower’s total monthly debt payments by their gross monthly income. Most lenders look for this ratio to be 43% or lower,” says Enright.
How quickly are HELOCs approved?
This depends on the lender, but your HELOC could be approved in just five days with automated appraisals. With more traditional full appraisals, it could take three to four weeks.
Sources
- Ryan Dossey, cofounder of SoldFast, a real estate brokerage/home-buying franchise
- Corey Vandenberg, mortgage loan officer at Lake State Mortgage
- Kyle Enright, president of lending at Achieve, a digital personal finance company in San Mateo, California
About Caitlyn Fitzpatrick
Caitlyn Fitzpatrick has been a professional writer and editor since 2014 and entered the commerce journalism world in 2017. She’s passionate about helping readers make smart buying decisions by using data insights and interviewing experts. Most recently, Fitzpatrick was the Senior Shopping Editor at Trusted Media Brands, where she led affiliate content on Reader’s Digest. In addition to Benzinga, Fitzpatrick’s work can be found in a range of publications, including U.S. News & World Report’s 360 Reviews, Today’s Parent, Betches, WhatToWatch.com, PS (formerly Popsugar), and more.
