Don't Get Tripped by Home Equity Loans

In the famed Star Wars series, villains drew much of their power from the "dark side of the Force."  In the world of home equity loans, there's also a dark side.  Make sure that you understand it fully before you take out a big loan.

Fortunes have been built on the backs of home equity loans.  Risk takers have tapped the equity in their homes to launch businesses, invest in the stock market, or buy real estate.  
    
Notice the words "risk takers."  It's important to keep this concept in mind, because whenever you're taking out a loan, there's always a degree of risk involved.  This particularly applies to interest-only home equity lines of credit (HELOCs).  This type of loan allows you to access significant funds at extremely reasonable rates.  However, it does have its fair share of risks that a potential borrower should understand.

Many benefits

A home equity line of credit is similar to a credit card.  You're given a credit limit and can draw against it, as needed. You pay interest only on the amount of money that you borrow.  Unlike a credit card, which is unsecured, the money in this case is secured against the equity in your home.

The rates on HELOCs are very reasonable when compared to other loans, and many banks will allow you to convert to a fixed-rate home equity line of credit if you think the variable rate has grown too high.  Finally, interest payments are tax-deductible.

On interest-only lines of credit, you're allowed to pay only the interest on the loan for a specified period of time.  These tend to range from the first five or ten years of the loan.

Prepare for the bump

After the introductory period is over, your lender will bump up the required payment.  At that point, your loan payments will rise, and you'll have to start paying off some of the principal.

Before you take out the loan, make sure that you'll be able to afford the new payment.  Don't take out an interest-only loan with the hopes that someday, in some way, you'll be able to come up with more money to cover the payments.  You should have enough money in your budget to cover the eventual bump.  If your payments increase and you can't cover the difference, you could fall behind on your mortgage, which could devastate your credit report and potentially lead to losing your home.  

The benefits of a home equity loan are undeniable.  If you have equity in your home, you can access significant amounts of cash at an extremely low rate.  But, like a credit card with an introductory period, you can really feel the pinch if you make the interest-only payments and ignore paying down the principal.  There's also risk to an interest-only home equity loan.  Make sure that you understand them fully in order to maximize your reward. If you get HELOC help, it may feel like the financial force is with you.