Yahoo Finance Rachel Cruze: Don’t Get Caught in the HELOC Trap — Here’s What To Do Instead
With the COVID-19 pandemic, recession worries and sky-high inflation somewhat waning, many Americans are breathing a sigh of relief. However, while these disruptions concerning the U.S. and global economy taught us to be cautious with our spending, many households are mired in debt.
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Consumer prices, interest rates and crippling debt continue to compromise the financial stability of American households. To deal with the financial challenges facing them, many homeowners are turning to home equity lines-of-credit, or HELOC loans, for help.
However, if you’re thinking of using your house as collateral for a home equity line of credit loan, you need to carefully consider if this is a prudent move or if you have other borrowing options. While HELOCs can help pull you out of financial trouble, they can just as easily become risky money traps.
That’s the view of financial expert and best-selling author Rachel Cruze, who, like her father Dave Ramsey, strongly advises against taking on more debt in an attempt to improve your financial situation.
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What is a HELOC and What Are the Risks in Taking One On?
A home equity line of credit (HELOC) is a secured form of credit. The lender uses your home as a guarantee that you’ll pay back the money you borrow. As a revolving credit, you can borrow money, pay it back, then borrow it again — up to the maximum credit limit of the loan.
Tapping into your home’s equity can help pay for retirement, unexpected or emergency expenses, home renovations or consolidating high-interest debts. Homeowners also use HELOCs for less urgent reasons, like buying vacation homes or investment properties and paying for a child’s wedding or college.
Because these loans often come with lower interest rates than credit cards, they can be the best (or only) choice for some people looking to turning their fortunes around. However, HELOCs can be fraught with risk.
“It’s like using your home’s value as an ATM, but also throwing money away in interest,” said Cruze on her YouTube channel. “So, you’re robbing your future self and going backwards with your net worth.”
Although HELOC loans are appealing because they come with rates lower than those attached to credit cards, the main risk with HELOCs is the fact that you are putting ownership of your home in peril. Defaulting or missing too many repayments could see you losing your home.
Because your home’s value has likely risen over the years — and especially over the past five years — it’s worth more than you think. Therefor, lenders will be offering bigger HELOCs than you probably need. With a large(r) amount of money at your disposal, you might be tempted to spend more than you need to (and on things that you don’t need).
Remember, just because you borrow funds against the equity in your home doesn’t mean that the HELOC is your money. You still have to pay it off and, for most people, it’s just another loan in addition to your mortgage.
“If you’re like most people, you haven’t paid off your mortgage yet,” said Cruze. “So, you don’t own your home outright. All you’re doing [by getting a HELOC] is adding new debt to the existing debt.”
Alternatives to HELOCs
Cruze believes that HELOCs are traps — and that putting your home and family in a precarious position can be avoided with a little financial planning. She suggested the following six alternatives to applying for a home equity line of credit:
1. Create an Emergency Fund
When unexpected car repairs, a job loss or urgent health expenses for you, your family members or your pet occur, you don’t usually have the time to adjust your budget. But these can be taken care of if you’ve built up an emergency fund. Having cash on hand means no debt, no high-cost loans and lots of peace of mind.
2. Reduce Your Mortgage
If too much of your income is going toward your mortgage, you could consider selling your home and downsizing to one that’s more affordable. Use a mortgage calculator or consult a financial advisor to see if this option makes sense for your current debt and homeownership situation.
3. Pay Off Your Debt
Cruze suggested using the debt snowball method to reduce the money you owe to others. This means paying off your smallest debts in full, first, then moving on to larger ones. But whatever method you choose, you have to get rid of debt, especially if your considering another big loan.
4. Build Your Savings
Setting savings goals for things like family vacations and home renovations will be easier on your finances if you build up your savings and pay for them with cash. Starting small and setting targets will make you feel better about these bigger expenditures, because they’re not putting other parts of your finances in danger.
5. Invest in Your Retirement
You don’t want to be without when the time comes to retire. Starting early is best, but putting aside some of your income every paycheck or every month (Cruze recommended 15% of your income) at any age will help you live more securely in retirement.
6. Spend Slowly
While many homeowners use home equity lines of credit on any number of expenses or to pay off debts, many use them to do renovations, build additions or install swimming pools. For big expenditures, piecemeal spending will help you dodge the HELOC trap.
As Cruze noted, we live in a world addicted to the quick fix, but bandage solutions only cover up bigger sores. “It’s not a bad thing to have to wait for something that you want.” said Cruze. “Delayed gratification is really nice. Instant is not always better.”
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This article originally appeared on GOBankingRates.com: Rachel Cruze: Don’t Get Caught in the HELOC Trap — Here’s What To Do Instead
