Home equity loans sound like a great way to get a cash boost, but like with all financial decisions, there are advantages and disadvantages to this option. This article provides information on how home equity loans and lines of credit function, what the various uses for them are, and some of their drawbacks.
What is a Home Equity Loan?
Home equity loan allows the homeowners to borrow money against the current value of their homes. Equity is the difference between the market value of your home and your current mortgage balance. So for instance if the value of the house is 300,000 and you still owe 100,000 to the bank then you have an equity of 200,000.
You can borrow some of that equity, say 50,000 or 100,000 through home equity loan in one go. These include the loan amount, the period within which the loan will be repaid, and the agreed interest rate on the loan. Repayment periods normally vary between half a decade and three decades.
Home Equity Line of Credit
A home equity line of credit (HELOC), on the other hand, is somewhat similar because you have a credit line on the equity rather than receiving the money all at once. It is an open line of credit that one can borrow in needed amounts up to certain limit and only accrue interest on the amount borrowed. These can be variable rate, have option to make interest-only payments, and normally have a 10 to 15 year period in which the money can be drawn.
Advantages of Home Equity
There are a few potential benefits that make tapping home equity appealing:There are a few potential benefits that make tapping home equity appealing:
Consolidate high-interest debt: If you have incurred large credit card bill or other consumer debt, you may be able to leverage home equity loan or a line at a cheaper rate. This makes the debt more manageable.
Finance home improvements: Home improvements – this includes remodeling projects, a pool installation, new roof and other major home improvements can be undertaken by borrowing through a home equity loan.
Pay for college: Another reason for taking a home equity loan is to pay for a child’s college education if savings are inadequate.
Bridge emergency costs: Unforeseen major expenses such as hospital bills or loss of a job may compel one to borrow equity when there is no other option.
Possible Drawbacks of Home Equity Financing
While home equity financing has its merits, there are also some important drawbacks:While home equity financing has its merits, there are also some important drawbacks:
Risks home ownership: A home equity loan also means that there is less equity standing as a buffer for your ownership stake. It is also important to know that if you find yourself in a position where you have to sell the house, you may be upside down on your mortgage and owe more than the house is worth due to a change in your financial status.
Comes with fees: There are closing costs involved in getting a home equity loan that can be in thousands depending on the amount of money you want to borrow. There are often also costs of appraisal.
Variable rates vulnerable: Even though interest rates on HELOCs can be initially very low, they are variable and depend on more general indexes. It is a possibility that payments will increase from the beginning to the end of the project.
Encourages overspending: This financial flexibility coupled with the availability of revolving credit through the HELOC can be somewhat alluring to some consumers and sometimes result in spending beyond their means. The draw period is 10-15 years which makes the payments look rather attractive at the beginning of the draw period as well.
Puts house at risk: If you encounter difficulties in repaying the loan, then you risk losing your home as security. Failure to make home equity loan payments adversely affects your credit rating and you may face foreclosure if you cannot make up for the missed payments.
Some of the tips that can be followed when dealing with home equity loans are as follows:
If you decide proceed with tapping home equity, some smart management goes a long way:If you decide proceed with tapping home equity, some smart management goes a long way:
Lock fixed rate: Choose a home equity loan with a fixed interest rate instead of an adjustable HELOC to avoid fluctuating monthly payments.
Take what you need: It is recommended to be quite cautious and selective with the equity one uses rather than trying to use all the available limit. Lend only what you can reasonably anticipate you will use in the near future.
Pay down aggressively: Additional payments to pay off a home equity loan early help to save a great deal of interest costs in the future.
Have solid job security: Having a regular source of income through stable employment means you can comfortably pay added monthly loan payments occasioned by equity financing.
Maintain your home: Continue to reside in the home for the long term and make mortgage payments on time along with the home equity loan payments. Also enable for home maintenance and repairs to help sustain the value of the property.
Weigh the Tradeoffs
Thus, using the money available in home equity through cash out refinancing, home equity loan, or HELOC facilitates the required funds for essential expenditures, improvements, or purposes. But at the same time, it removes equity that shields your ownership percentage and includes danger in case your financial status worsens. Think carefully about the numbers, consider other options, such as, getting another loan at a lower interest rate, and always consider the worse case scenario before deciding whether home equity loan is suitable for you or not. Another aspect that will be important when you have the loan will be wisely handling of payments as well.
