HELOCs can come with hidden costs
Costs associated with a HELOC
- Annual fees
- Transaction fees
- Inactivity fees
- Cancellation fees
One potential benefit that home equity lines of credit (HELOCs) offer compared with other types of loans is a lower interest rate. Because a valuable asset — your home — is used as the collateral for this line of credit, many lenders will provide a HELOC at a lower rate than several other types of debt to be used for similar purposes.
That low interest rate, however, could be short-lived. Oftentimes, HELOCs come with variable interest rates, meaning the rate can (and will) change over time. These rates are based on a publicly available index, such as the U.S. Treasury bill rate or the consensus prime rate. This is in contrast to many homeowners' fixed-rate mortgages, in which interest rates remain constant over the life of the loan.
How do HELOC rates work?
The Consumer Financial Protection Bureau (CFPB) has several pieces of advice when it comes to variable-rate loans, which can be easily applied to HELOCs. Before you get such a line of credit, make sure you know:
- How frequently your rate can (and will) adjust;
- What your payments will become with each adjustment; and
- How soon your rate may increase.
By law, variable-rate HELOCs must have a cap on how high the interest rate can rise. In contrast, some lenders may also limit how low a variable interest rate can drop. In any case, be sure you plan on your interest rate increasing, and be sure that you are comfortable making payments if (and when) that occurs.
"If you can't afford the higher payments on today's income," the CFPB warns, "you may want to consider another (kind of) loan."
Some lenders do offer fixed-rate HELOCs, but they are typically more difficult to find than variable-rate versions. More likely is that you could find a lender that will allow a HELOC to covert from variable to fixed-rate at some point.
What kind of fees do HELOCs have?
Even if you do find a fixed-rate HELOC, there may be other unexpected impacts on your finances if you do choose such a line of credit. Namely, there may be fees associated with your line of credit.
Many of these fees fall outside of the typical fees and closing costs that are associated with virtually any mortgage — and some of the fees may be hidden in the fine print of your agreement. These could include the following:
- Annual fee: A fee that you must pay each year that you have the line of credit.
- Inactivity fee: A fee that you must pay if you do not use your HELOC.
- Transaction fee: A fee that you must pay every time you draw from the HELOC.
- Cancellation fee: If the HELOC is canceled within a few years of its opening, you could be charged a fee.
"Before you take out a home equity line of credit, be sure to read the documents carefully to see what your lender can charge you," the CFPB says.