When we bought our house 8 years ago the bank recommended that we apply for a HELOC instead of a traditional mortgage. HELOC stands for home equity line of credit and it is a revolving line of credit that is secured against the equity in our home. There are some advantages to borrowing with a HELOC but there are a number of drawbacks as well.
We choose a blended HELOC; with 70% locked in at a fixed rate/fixed term and took the remaining 30% as an open, variable rate, line of credit. We make regular biweekly mortgage payments on the fixed portion and the line of credit only requires a monthly payment equal to the accrued interest.
Benefits and Drawbacks of a HELOC
(or things the glossy marketing brochures don’t tell you….)
- The line of credit portion provides very flexible, easy, access to credit. This can be a both a blessing and a curse. It is great if you want to take advantage of a sale in the stock market or buy a hot tub. (Tip: Don’t buy a hot tub.) It’s a curse if you can’t control your spending or are running a deficit each month and the outstanding balance keeps going up.
- HELOC rates are usually better than fixed mortgage rates and can save you thousands in interest costs over the life of the “mortgage”, but the rates are not locked in. We live with the risk that our rate could go up at any time. Interest rates have been low and it looks like they will remain that way for some time but there are no guarantees. Even the experts can’t figure out which way the economy is going so the risk is real.
- The line of credit portion of our HELOC is reported on my credit bureau (even though the fixed rate mortgage portion is not.) This was a bit of a credit check surprise. We only borrowed what we needed to finance the house so there is not a lot of extra available credit and it makes my credit utilization amount look really high. On my credit report if kind of resembles a maxed out credit card. This could have a negative impact if we decide to apply for additional credit in the future.
- The borrowed amount declines each month as payments are applied, which increases the amount of available credit. Great, more credit! The drawback is that it can give you a false sense of accomplishment because the balance may decline overall, but if you are not careful you can start shifting some of the balance from the fixed rate portion to the line of credit and not even realize it.
- Our borrowing agreement states, “At our option we may demand payment in full of the Outstanding Balance even if you have made each Minimum Monthly Payment.” Yikes! Also in the fine print at the end of our contract there is a clause that reads, “We are not required to give you reasonable notice before refusing you credit at any time.” I think it would be unlikely that our lender would do this because of the equity we have in our house, but I guess we need to remember that the HELOC is not our money and we could lose access to it if our circumstances change.
HELOC & Lazy Personal Finance
We use our HELOC account like it is a checking account. We write checks against it, set up pre-authorized payments, and pay bills online. Is this lazy financial management?
When we get paid we deposit our paychecks to the line of credit and draw on it as the bills come in during the month. We do save interest doing this. By my calculation, we have saved about $4,000 in interest using this method, BUT I am not sure if it has been worth it. I feel a great deal of satisfaction seeing the balance drop on payday, but then I feel of stress watching the balance climb again.
This might sound like a contradiction but the lazy method does require a certain amount of discipline to ensure that you are not spending more than you deposit. But here is what is lazy about it–it helps us avoid banking fees, overdraft or thinking too hard about our budget. It also helped us pay down our HELOC balance by over $20,000 in 2013. Sounds great, but would we have been better off practicing active financial management and putting that money in our retirement accounts, saving for the kids education or something else? That is the gist of my HELOC headlock.
Shared as part of Friday Jet Fuel # 8 @