Tapping home equity can create a debt cycle for some homeowners

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As millions of Americans file for unemployment benefits, some may look to their home equity to free up more cash or pay down existing debt.
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But that strategy could backfire, according to one survey, leaving homeowners in debt again and eroding their equity wealth.

Almost 1 in 4 homeowners who paid off their home equity line of credit, or HELOC, borrowed against it again later on, according to an exclusive survey provided to Yahoo Money from personal finance site Online Loans.

The average homeowner borrowed $25,000 with their home equity line of credit and took up to three years to pay it off, the study found. A HELOC is a revolving line of credit that uses your home as the collateral and comes with a variable interest rate.

“A HELOC can be a very cost effective, easy way to borrow money. However, the simplicity and low barrier to borrowing can also be dangerous for your behavior around money,” said Jake Northup, a financial adviser at Experience Your Wealth. “It’s like eating ice cream out of the carton instead of eating it out of a bowl. It’s easy to overindulge if you lack the discipline to stop yourself.”

When is it safe to take out a HELOC?

As long as home values continue to appreciate, which they have —  rising more than 31% in the past five years — according to real estate site Zillow.com, then you can safely tap into your home equity.

As long as home values continue to appreciate, which they have — rising more than 31% in the past five years — according to real estate site Zillow.com, then you can safely tap into your home equity. (Source: Getty Creative)

“As long as home prices remain stable, there’s nothing to be concerned about,” said Lawrence Yun, chief economist at the National Association of Realtors. “But if prices go down, the person who took out their equity will feel an emotional shock factor as their wealth situation is declining.”

Always make sure to have a plan to pay off the HELOC. Otherwise, you may spiral into further debt.

“Using a HELOC to cover short-term financial challenges, especially now, can be a good idea, but you need to have a plan in place to pay it off once you overcome those challenges,” Northup said. “If you are dependent on a HELOC to maintain your current standard of living, it means you are spending above your means and something needs to change.”

Among those who accumulated debt after taking out a HELOC, more than 80% fell into credit card debt, according to the Online Loans survey.

HELOCs entice borrowers because of their low interest rates compared with credit cards. But because the rate is variable, some borrowers may have a difficult time paying later on if the rate increases. When considering a HELOC, do it for the right reasons.

“Before you tap into your HELOC, ask yourself “why am I needing to borrow this money right now”,” said Northup. “Are you using the money to invest in something that is expected to appreciate in value, such as a home renovation, or to cover your living expenses?”

This article was originally posted on finance.yahoo.com/news/.

 

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