What Disqualifies You From a HELOC?
A HELOC isn’t for everyone. Even if you own your house in its entirety, insufficient income may still disqualify you for a HELOC because, in the end, financial institutions want to ensure that you can afford to pay back your loan. When you start the loan process with DCU, you’ll submit financial documents which will include but aren’t limited to:
- Recent pay stubs
- Two years of tax returns
- Bank statements
- Current mortgage statements
Are HELOC Loans a Good Financial Move?
HELOCs usually have significantly lower interest rates than most credit cards, which makes borrowing through a HELOC generally less expensive. However, you should only borrow what you can comfortably repay. If the payments would put pressure on your budget, this isn’t the right loan for you.
A HELOC is a good option to fund many projects and expenses. You can get a full list when you read our article on smart uses for a HELOC. This line of credit is often used for home improvements or repairs.
Smart borrowers consider the return on investment when using borrowed money. For instance, let’s say you’re using your HELOC to remodel your home. While turning your guest bedroom into a closet for the ultimate shoe display might appeal to you, the change may take value away from your home. If, however, you’re using that same money to upgrade your furnace to something more efficient that will make your home warmer, that’s a selling point for future buyers. Even if you’re planning on staying in your home for the rest of your life, when you make valuable upgrades to your home, you add equity to it and in doing so, you add to your own assets.
While there are many reasons to pursue a HELOC, there are also some potential issues that people can run into that can strain their finances:
- Borrowing outside of your means: Only borrow what you’ll be comfortable repaying. Once the line of credit is open, it can be tempting to use it more than you were planning. Before opening the credit, set a cap on how much you’ll use and stick to it. If you need to spend more, it’s time to draw up a new budget to see if you can afford to pay back that new expense.
- Misallocating the funds: Have a clear use for your HELOC. If you open a line of credit to remodel your home, set boundaries. Spending your funds on lunch after making a trip to the hardware store can be a slippery slope to more frivolous spending of money meant for something very specific.
- Not understanding the fine print: Before opening a line of credit, know the details. What are the fees and terms? Review the terms and conditions before signing and ask for help if you don’t understand the details.
Things to Consider Before Getting a HELOC
A HELOC uses your home as collateral, so it’s worth taking a moment to be sure it aligns with your financial comfort level. A HELOC isn’t free money — it still comes with costs, just like any other line of credit. Before you decide to borrow this way, it’s worth understanding a few potential drawbacks:
- Variable interest rates: Many HELOCs have variable interest rates, which means your interest rate will change at certain intervals — it may be monthly or annually. If interest rates are rising, your loan will become more expensive. DCU does offer fixed-rate HELOCs for qualifying members.
- Interest-only payments: When your HELOC is in its drawing period, you only pay interest which makes your monthly bill cheaper, until you get to your repayment period. It’s important to budget ahead of time and remember to plan for that more expensive payment period as you’re withdrawing funds from this line of credit.
- Easy money often becomes expensive money: While a HELOC can be more accessible for borrowers with lower FICO scores, relying on it can encourage overspending and ultimately increase your overall debt burden.
- Impacts your credit score: A HELOC influences your credit much like a credit card. Drawing funds doesn’t immediately affect your score, but missing payments during the repayment period can significantly harm your FICO rating.
Can I Open a HELOC and Not Use It?
Typically, when you open a HELOC, you’ll be asked to take out a minimum required advance. At DCU that’s $500. After that, some people choose to use their HELOC as a safety net or even as overdraft protection.
It’s important to fully understand your HELOC’s terms and conditions. Sometimes there are associated fees (even when you’re not actively using the line of credit) including application fees, closing costs, and inactivity fees. You may also want to ensure that you won’t be charged a cancellation fee if you decide you no longer want your line of credit.
Making the Final Decision: Is HELOC Right for You?
A HELOC can be a divisive subject. Is this lending option the answer to your money problems or a potential risk and pathway to difficult debt? The answer depends on your goals and personal financial situation.
Are HELOC loans good for your finances? Sometimes. If you have a lower credit score but are financially stable and able to budget your payments to plan for your repayment period, then borrowing through a HELOC for a reason that will add stability to your financial future may be great for you.
Opening a HELOC is a long-term commitment. The drawing period typically lasts five to 20 years, which is why it’s great for longer remodeling projects or paying higher education tuition. That long-term commitment should line up with your long-term financial goals. If you’re adding value to your home or setting yourself up for a higher-paying job, you’ll be better prepared to face the repayment period. If you need a quicker solution to your money problems, however, this way of borrowing might give you more money struggles in the long run.
The Good, the Bad and the HELOC
When people are researching HELOCs, one of the most popular phrases searched is “Are HELOCs a good idea?” The truth is, they are great for some not so great for others. It all depends on your spending habits, your goals and your financial situation. If you still have questions about this line of credit, reach out to a professional for financial advice.
At DCU, we offer our members free financial counseling through our Balance program. If you’re not a member, speaking to a local financial counselor may help you understand more about this type of loan and help put your financial situation in perspective.
A HELOC isn’t free money, but it can be a tool to help you achieve your goals. Are you interested in borrowing with a not-for-profit financial institution that will keep you informed, every step of the way? Learn if becoming a DCU member is right for you. We’d be honored to help you in your financial journey.
Please note, membership is required to open any account or loan with DCU. Visit our membership eligibility page for more information.
This article is for informational purposes only. It is not intended to serve as legal, financial, investment or tax advice or indicate that a specific DCU product or service is right for you. For specific advice about your unique circumstances, you may wish to consult a financial professional.
