Where home equity lines go wrong, and how to avoid the common problems

A home equity line of credit is a flexible tool, and flexibility cuts both ways. The same features that make it easy to borrow can make trouble hard to see until it arrives. This guide covers the problems that come up most often and what a borrower can do about each one.

Key takeaways

The line is secured by your home, so missing payments puts the home at risk.
The payment can rise sharply when the draw period ends or when the rate moves.
A lender can freeze or lower a line under conditions written in the agreement.
Planning the repayment before the first draw prevents most of the problems described here.

Why the stakes are higher than for a card

A credit card is unsecured, which means the lender has no claim on a particular asset. A home equity line is different. It is secured by your home, so the lender holds a legal claim on the property until the line is repaid and closed.

That claim is what makes the borrowing cheaper than many alternatives. It is also why the problems below deserve attention. If payments stop, the lender may begin a process that can end with the sale of the home.

Payment shock at the end of the draw period

Many lines start with a draw period, during which you can borrow and may be asked to pay only the interest. When it ends, the repayment period begins. You can no longer borrow, and each payment must now cover principal as well as interest.

The change can be large. Paying principal on top of interest means the bill can rise by a wide margin, even if the rate has not moved.

An illustration with round numbers. Suppose a balance of $30,000 and an interest-only payment of $150 a month. If the repayment period spreads the balance over a number of years, the new payment has to cover both pieces, and it can be several times the old one. The figures show the shape of the change. They are not a prediction and not an offer.

To avoid the surprise, ask the lender for a payment table that shows both periods, and decide in advance how you will pay the balance down while the draw period is still open.

A variable rate that keeps moving

Most lines carry a rate that follows an index. When the index rises, your rate and your payment rise with it. The agreement usually sets a cap, which is the highest rate the line can reach.

Check the cap, and then work out the payment at the cap. If that payment would strain your budget, borrow a smaller amount or choose a structure with a fixed portion. Some lenders let you lock part of the balance at a set rate; ask whether the line you are considering allows it.

A line that is frozen or reduced

The agreement lets the lender suspend or lower the limit under stated conditions. Typical triggers are a sharp fall in the home's value, a material change in your finances or a missed payment.

The practical risk is planning. If you count on the unused part of the line to cover a future bill, a freeze can leave you without it at the moment you need it. Treat the open limit as a convenience, not as savings.

Overdrawing: using a line like income

Because money is available on request, it is easy to draw for everyday costs and let the balance grow. Interest builds on every dollar drawn, and the balance does not shrink unless you pay more than the interest.

Many borrowers find it helpful to keep a simple record of every draw. Keep draws tied to a purpose and a payoff date. A line used for a one-time project has an end. A line used to cover monthly shortfalls does not.

Owing more than the home is worth

If home prices fall after you borrow, the total secured by the home can exceed its value. That makes it harder to sell, to refinance or to open another line. Borrowing a smaller share of your equity leaves a cushion for this. It also helps if you plan to move within a few years, since the line must be paid off and closed when the home is sold.

Habits that lower the risk

Write down what each draw is for and how you will repay it.
Pay more than the interest whenever the budget allows.
Calendar the date the draw period ends, and the date the first larger payment is due.
Check statements each month for fees you did not expect.
Keep a separate cash reserve so that a frozen line does not stop a plan.

If a payment becomes hard to make

Contact the lender before a payment is missed, not after. Lenders often have options for a borrower who asks early, and they have fewer once the account is behind. A nonprofit housing counselor can also review a budget at no charge to the borrower in many cases, though availability varies by location. Keep copies of every letter and message with the lender, and note the date of each call.

About this guide. Harlow Connect put this risk guide together as plain background for homeowners weighing a line of credit. Each lender sets its own terms, so read your agreement closely before you draw on it.