Why You Should Consider HELOC Alternatives

HELOCs are adjustable rate mortgages. That means the rate can go up after you get the HELOC. Your rate may start low, but it can change over time.  Some banks and credit unions allow the rate to rise to extremely high levels. That’s why you should be cautious when considering a HELOC.

Because HELOCs carry very high maximum interest rates, some banks and credit unions bury their maximum interest rates in page after page of legal fine print. But a quick internet search of banks and credit unions offering HELOCs in May 2020 turned up five that put the maximum interest rate in writing on their website.

Maximum Interest Rate

Are you sitting down?  You should be, this may make you light-headed. The maximum annual percentage rate for two of the five banks and credit unions was 21%!  That’s right, 21%!  None of the banks or credit unions surveyed had maximum annual percentage rates under 16%.

Now, some may say that maximum is very unlikely. But, the same could be said about the 2008 financial crisis or the 2020 COVID-19 crisis. Almost no one saw either one of those crises coming. How can you be sure that your interest rate won’t go to the maximum? You can’t.

Payment Increases

Some think the only way a bank or credit union can charge more each month on a HELOC is by raising the rate.  That unfortunately is not true.  You can experience payment shock from being required to pay off the remaining balance on the HELOC over a short term.

Almost all HELOCs start with a payment that only pays the interest due each month (the interest-only period).  The amount of the debt, also called the balance, stays the same.  So, when you start your HELOC, your payment does nothing to lower the balance.  But the interest-only period only lasts for part of the term of the HELOC.  After that period is over you have to pay the full balance due.

You’re probably wondering how fast you have to pay it. For example, of the five banks and credit unions surveyed on the internet in May 2020, all had repayment periods of 20 years or less. One was as low as 15 years and one was even 10 years.  How painful a shock is it to pay off your HELOC that fast?  Let’s say your rate starts low but interest rates rise a few percent by the time you have to pay off your HELOC over 15 years.  You could see your required minimum payment double or even triple!  That’s a dangerous feature of most HELOCs that many people don’t know about.

Payment Penalties

A prepayment penalty is a penalty charged by a bank or credit union HELOC when you pay off and close a HELOC before the end of the loan term. You might think prepayment penalties are outlawed, but that’s not true in some cases with banks and credit unions. So if you get a HELOC the fine print in the documents may mean you will pay a penalty if you pay off or close your HELOC before the end of the loan term.

Negative Amortization

Negative Amortization is lending jargon for making a payment on your mortgage but seeing your balance rise. Ideally, your bank or credit union would never make a loan to you with Negative Amortization. Well, one of the five banks or credit unions surveyed in May 2020 actually stated that in some cases your monthly payment will not cover the interest due and your balance will go up. It’s truly amazing that this feature exists in HELOC’s. How can you know that your HELOC does not have this feature buried in the dozens of pages you signed?

Legal Fine Print

There are other risks of HELOCs that you should worry about, but here’s one more that will shock you. This feature was buried in the legal fine print for one of the HELOCs surveyed in May 2020. Here it is – one HELOC required you to occupy the home as your primary residence as long as the HELOC was open. So, if you get a HELOC and 10 years from now would like to rent your home and buy a new home, you may be in trouble with your bank or credit union. How do you know that’s not a part of your HELOC when the documents are long and hard to understand?