Home Equity Loans - Pros And Cons

What are the pros and cons of home equity loans?

2 Answers

Having a hard time making ends meet? Interested in consolidating credit card debt? Wish you had extra cash to make home improvements, buy a new car or go on a vacation? If cash is what you need, then a home equity loan could be right for you.

What Are They?

A home equity loan is just like any other type of secured loan that you might get from your bank or credit union. In the instance of home equity loans, however, what you're putting up as collateral is-you guessed it-your home.

There are two types of home equity loans: the home equity loan and the home equity line of credit. The home equity loan is granted in one lump sum and the borrower pays a set monthly amount-not unlike a home mortgage, while the home equity line of credit comes with an approval for a certain loan amount and the choice whether or not to use it. The home equity line of credit is typically a checkbook or credit card issued with an approved amount in the account. If you use money from the account, you must pay back that amount plus interest; if not, you don't pay anything (or, in some cases, simply an annual fee).

The Pros and Cons Perhaps the most obvious advantage of a home equity loan is that the loan amount can be used however you wish-whether it's for alleviating debt, funding an emergency or getting cash for college, a vacation or home renovation.

Another advantage is that the interest (on loan amounts up to $100,000) may be tax-deductible. However, keep in mind that the tax-deductible portion is based on a percentage, so if you're in a higher income bracket it may amount to nearly nothing.

The primary disadvantage of home equity loans is that they are similar to an additional mortgage on your home; if you can't make the payments, it puts your home at risk for foreclosure.

Home equity loans are also risky decisions for people facing career changes; if your income changes for the worse, your home will be at risk. Likewise, if your home's value drops, you might end up owing more on your property than it's worth-bad news if you need to sell the house later.

Are Home Equity Loans Right For Me?

When deciding whether or not a home equity loan is the right decision for you, consider your short- and long-term goals. Home equity loans are good options for those looking to borrow a lump sum amount and reap long-term rewards-such as a major home renovation or the consolidation of high interest rate credit cards.

Conversely, home equity lines of credit are often better for those focusing on the short-term. They can be good ways to plan for unexpected, immediate financial needs. They are also popular options when facing a long-term project-say, a remodel or renovation that will be done over a period of time-that requires payments at intervals rather than in one lump sum.

If you're thinking of home equity loans as means to consolidate debt, be sure to consider the long-term effects. It may mean a smaller payment now, but it could equal more debt in the long run, depending on the term and rate of the loan.

Ultimately, it's important to consider your financial situation before applying for any type of loan. Be sure to weigh all of the advantages and disadvantages. And don't think of home equity loans as "quick fixes" so much as important decisions for your financial future.