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As the holiday season approaches and year-end expenses loom, many homeowners are considering tapping into their home equity with a home equity loan or a home equity line of credit (HELOC). That can be a smart plan, especially right now, considering that these borrowing options typically have some of the lowest rates available — and that the average homeowner has about $319,000 worth of home equity to tap into.
But while home equity loans and HELOCs are both worth considering, HELOCs, in particular, can be an attractive option for accessing your home’s equity in today’s market. With a HELOC, you get low average rates and access to a line of credit that can be borrowed from multiple times (up to the limit), offering you more flexibility than you’d get with a lump-sum home equity loan.
However, the decision to borrow against your home’s equity shouldn’t be taken lightly, especially during the holiday season when the pressure to spend is at its peak. While HELOCs can be valuable financial tools when used wisely, they can also come with risks that could put your home and financial stability in jeopardy — so it’s important to avoid the big mistakes borrowers make with this option.
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6 HELOC borrowing mistakes to avoid this December
Here are a few key mistakes to avoid when borrowing from a HELOC this December.
Treating your HELOC like a holiday windfall
The temptation to use HELOC funds for holiday gifts and celebrations can be strong, especially when credit cards are maxed out or savings are running low. However, using your home equity to fund temporary seasonal expenses is a serious financial mistake. After all, you’re borrowing against your house — one of your most valuable assets — and the items you’re purchasing will likely depreciate or be consumed long before you’ve finished paying for them. Holiday expenses should ideally be covered by current income or dedicated savings, not long-term debt secured by your home.
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Borrowing without understanding variable rates
Another common mistake that HELOC borrowers make is failing to fully grasp how variable interest rates work. Unlike fixed-rate home equity loans, HELOCs typically come with variable rates that can fluctuate significantly over time. While HELOC rates might seem attractive now, and if rates drop over time (as expected) it could make them even more enticing, it’s important to remember that the rate environment can change quickly.
If rates climb, the rate on your HELOC could rise substantially in the future, potentially making your monthly payments unaffordable. So before opening a HELOC this December, make sure you’ve calculated how your payments would change under different interest rate scenarios and have a solid plan for managing potential rate increases.
Focusing solely on the draw period
Many homeowners make the critical error of focusing solely on the draw period without preparing for what comes next. During the draw period, which is the period when you “draw” from your line of credit, you typically only need to make interest payments, but when that draw period ends, you’ll need to start repaying both principal and interest. This can lead to payment shock if you haven’t planned accordingly. Prior to opening a HELOC this December, then, it makes sense to create a detailed repayment strategy that accounts for the eventual end of the draw period and the higher payments that will follow.
Overborrowing and reaching your limit
The convenience of the line of credit you get with a HELOC can lead to overborrowing, and it’s crucial to borrow only what you truly need and can repay comfortably. Maxing out your HELOC not only limits your financial flexibility but can also negatively impact your credit score (and, as a result, your overall financial picture). If you plan to open a HELOC this December, just be sure to carefully evaluate your needs and avoid using your HELOC for non-essential expenses.
Ignoring the risk to your home
Unlike other types of credit, a HELOC is secured by your home, and failing to make payments on what you borrow could ultimately result in foreclosure. This is especially critical during December when budgets are often stretched thin and the temptation to borrow more than necessary increases. To safeguard your home, only borrow what you can confidently repay and prioritize HELOC payments in your financial planning.
Misunderstanding the tax deduction rules
Some borrowers mistakenly assume all HELOC interest is tax-deductible, leading to poor borrowing decisions based on anticipated tax benefits. But HELOC interest is only deductible if the funds are used for buying, building or substantially improving the home that secures the loan.
Using HELOC funds for debt consolidation, education expenses or other purposes can be a good move depending on your needs, but it also means losing the tax deduction benefit. Before taking out a HELOC this December, it could benefit you to consult with a tax professional to understand exactly how your intended use of the funds will impact your tax situation.
The bottom line
Tapping into your home equity through a HELOC can be a valuable financial tool when used wisely. However, the key to success lies in avoiding common mistakes that could undermine your financial health. So, this December, let your HELOC be a strategic asset and not a financial liability. Make sure to approach this type of borrowing with caution, prioritize responsible borrowing and enjoy the peace of mind that comes with making informed decisions.
