Mortgage rates in 2022 climbed as high as 7% and have since settled at an average of 6.21% when 2023 rolled around. Many parts of the real estate economy were affected by the big changes in mortgage interest rates.
One notable effect these wildly swinging interests have is on cash-out refinancing. Homeowners used to favor cash-out refinancing to access the equity they have in their homes. It worked by refinancing their mortgage to a higher amount, letting them cash out the difference.
Now, property owners are switching to a home equity line of credit, or HELOC, instead. It is a home equity loan that functions like a credit card, and some lenders even give homeowners a credit card to take out their HELOCs. Helocs are extremely lucrative because they often have lower interest rates than personal loans or credit cards. Whereas personal loans can rack up about 10% interest, HELOCs charge less than that, depending on the credit score.
Aside from the interest rates being significantly lower, HELOCs are also convenient because they can be withdrawn by card or cheque in increments, unlike other loans released in full. Hence, property owners who want to improve their homes and need some cash immediately are drawn towards HELOCs, since they don’t need the money in bulk.
Upfront fees are also lower with HELOCs, and the process to get approved is much like being pre-approved for a credit card–it is almost automatic.
However, despite all the conveniences HELOCs provide, there are still aspects to be wary of when getting a HELOC. One example is that HELOC interest rates can change instantaneously, so it is hard to plan your expenses around it.
Another hurdle with HELOCs is directly tied to their convenience. Because it works like a credit card, it can be paid like a card as well, where people can pay off just the interest and never make a dent in the principal. So at the end of the payment period, the homeowner is left to pay off what he owed in the first place. But this could be solved with proper budgeting, of course.
People also often use HELOCs to consolidate their debt. They use the money from the cash-out to pay off their credit cards, most of the time, so they’ll be left to reimburse everything on just one line of credit. This can be a good choice for those who want to improve their credit scores, but it can be a slippery slope as well. It can lull people into a false sense of complacency that they only have one debt until they are overwhelmed by the amount of the debt.
HELOCs have their advantages and disadvantages. Some say the pros outweigh the cons compared to doing a cash-out refinancing. However, no matter what kind of loan or refinancing it is, people should always keep in mind that debt is a debt. At the end of the day, they still have to pay it off. It helps to ask expert opinion on what you can do with your mortgage.