Are HELOCs A Dangerous Game? Suze Orman Warns, 'Your Home Is Collateral For A HELOC'

Personal finance guru Suze Orman is worried about the 20% increase in home equity line of credit (HELOC) balances since the end of 2021.

While she understands the appeal of HELOCs in today's market, rising home values may mean someone's home far exceeds the remaining mortgage balance, making it tempting to tap into the equity for other expenses.

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And as mortgage rates have risen significantly over the past two years, refinance an existing mortgage doesn't make sense if the new one comes with a much higher interest rate.

Making informed decisions is important if you're considering getting a HELOC or have recently opened one. Here's what Orman wants you to know:

• A HELOC uses your home as collateral, meaning you risk losing your house if you fall behind on payments.
• Lenders can suspend or reduce your credit limit. When home prices fall and finances tighten during a severe recession, lenders may lower your credit limit or close your HELOC – which happened during the financial crisis.
• Most HELOCs come with adjustable interest rates. Typically, you have a 10-year draw period during which you can borrow and repay the amount or make interest-only payments. After that, you'll have another 10 years to repay the balance. But because the interest rate is often adjustable, rising rates could increase repayment costs.

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Although HELOCs come with risks, if you choose to use them wisely, you can make smart decisions about how to do so.

"For starters, you are never ever to use a HELOC to pay for a ‘want,'" Orman advises. "With your home as the collateral, there is just no argument for borrowing – and owing interest – on a loan for a vacation or a nicer-than-needed car or some home upgrade that is nice to have but not necessary."

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If you're considering opening a HELOC as "just in case" insurance for emergencies like an illness or job loss, Orman said it's important to remember that lenders can alter the terms of HELOCs at any time, including freezing your access. This makes a HELOC an unreliable way to plan for emergencies.

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"The right way to protect yourself and your loved ones is to build up at least a year of living expenses in a standard savings account," Orman said.

If you need to use a HELOC for a genuine need, consider how long it might take to repay it. A HELOC with an adjustable rate could be fine if you expect to pay off the balance within a year or two. However, a fixed-rate HELOC may be a better option if you anticipate needing more time. Although the interest rate may be higher than an adjustable-rate mortgage (ARM), the fixed rate protects you over the years it will take to repay the loan, whereas an ARM leaves you vulnerable to rising rates during repayment.

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