You could end up paying more than expected over time.
- Different loans have different features that come into play during your payoff period.
- You’ll need to be careful with loans whose interest rates aren’t fixed.
There are different reasons why you might need to borrow money. Maybe you need to fix your car and you don’t have cash in your savings account to pay for repairs. Or maybe you want to renovate your home and need a loan to make that happen.
There are different loan products you can turn to when a need to borrow money arises. But financial expert Suze Orman cautions borrowers to be very careful when borrowing money under one specific circumstance.
When you’re not getting a fixed-rate loan
Some loans, like personal loans, come with fixed interest rates. This means that if you sign a loan at 6%, that 6% interest rate will apply to your debt until it’s paid off. It also means your monthly payments for that loan will stay the same over time.
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Variable interest loans work differently. And those are the ones Orman cautions borrowers to stay away from.
Credit cards, for example, tend to charge variable interest rates. So the rate you start out paying on your debt could get higher over time.
The same holds true for home equity lines of credit, or HELOCs. HELOCs are often hailed as an affordable borrowing choice because lenders only take on limited risk when issuing them (since they’re based on equity in an existing property). And, HELOCs can be very flexible. Once you get access to a line of credit, you usually get a good five to 10 years to draw from it as needed.
But Orman cautions that the problem with HELOCs is that their interest rates tend to reset monthly. And so while you might start out paying 5% interest on a HELOC, down the line, that 5% could evolve into 6%, 7%, 8%, or more, leaving you with higher payments to grapple with and forcing you to spend more on interest than you were expecting to.
A dangerous move right now
While it’s generally a risky thing to take out a loan with variable interest, right now, you need to be extra careful. The reason? The Federal Reserve is implementing interest rate hikes in the hopes of slowing the pace of inflation. That’s apt to drive consumer borrowing rates upward. And so if you sign a HELOC, you could get stuck paying more and more interest on your debt as interest rates climb across the board.
In fact, if you’re looking to borrow against the equity you have in your home, a home equity loan is probably a better bet. That way, your interest rate won’t change over time, and you’ll have an easier time factoring your ongoing loan payments into your budget.
Furthermore, while borrowing by charging expenses on a credit card might seem like the easiest route to take, it could also wind up being the most costly. Not only are credit cards notorious for charging high levels of interest, but their variable nature means you could really end up getting in over your head. So that’s a situation you’re best off avoiding.
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