Home Equity Loans: Advantages and Disadvantages
A home equity loan (HEL) is a secured loan, which uses your home as collateral. Homeowners who want to cash in on the equity built up in their home take out such a loan. A home equity loan is a good option when you have to make a major, one-time purchase such as a car or property, or have to pay towards a large expense such as a complete home renovation. Those with a lot of accumulated debt may also take out a home equity loan to consolidate the debt and manage repayments easily. As with any financial product, home equity loans have their advantages and disadvantages too.
How you benefit from home equity loans
As a homeowner, if you are in urgent need of a significantly large amount of cash, then a home equity loan can be very useful. The loan amount borrowed can be up to 100% of the value of the equity owned in the house. In some cases, where there is a significant equity built in the home and there’s a likelihood of the home value appreciating in future, lenders offer up to 125% of the home’s value. Not only can you borrow large amounts, you can also avail the loan at a lower interest rate. The rates offered are much cheaper than on unsecured loans, making a HEL an attractive option.
Another advantage of such a loan is that any borrowed amount, which is less than $100,000, is exempted from tax and no tax is levied on the interest paid on this loan. In a scenario where tax is charged on literally all types of consumer debt, a home equity loan’s tax-deductible feature is one of its major selling points. The payments are amortized, meaning fixed amounts of interest and principal have to be paid each month. This helps you plan your monthly budget better. The loan term ranges from a year to thirty years.
Shortcomings of home equity loans
The biggest and most obvious advantage of a home equity loan is that you are risking your home. A default may end up in a foreclosure depending on how much of the first mortgage is left to be paid off. Those homeowners who have a fluctuating income or who are self-employed will find such loans to be very risky. Several missed payments can trigger a foreclosure, especially if the lender is not sympathetic to your current financial situation.
Another shortcoming is that a second lien such as a home equity loan can reduce your owned equity in the home. With a drop in the value of your home, you can end up owing a larger amount than what your home is worth. This will create problems when you decide to sell your house sometime in the future. There are also costs associated with such loans, including closing costs, title search fees and lawyer’s fee.
Make sure that your lender discloses all costs associated with the loan. Remember that home equity loans can be generally cancelled three days after their opening, should you have second thoughts.
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