The Pros and Cons of Home Equity Loans

home equity loans

Property values have increased by an average of $30,000 since 2013.

That means most homeowners have more equity in their home, you can access your equity to get cash to make repairs or home improvements.

A home equity loan allows you access cash against the property value of your home.

You’re able to borrow large sums of cash and they’re typically easier to qualify for and come with lower rates.

You can use the money you get from a home equity loan for home improvements, repairs, debt consolidation, or pretty much anything you want.

You’re not required to only spend the money on improving or repairing you home, you can use it for anything.

Rate Search: Check Refinance and Home Equity Loan Rates

What is a Home Equity Loan

A home equity loan, also referred to as a second mortgage, is a loan that is secured by the homeowner’s equity. Home equity loans are a second loan with a separate payment and term, generally between 5-15 years.

The interest rate is lower than other types of personal loans with an average rate around 5%. They are also easier to qualify for because your home’s equity is used as collateral.

Home Equity Loan Benefits

  • Large loan amounts: Usually personal loans are limited to $40,000, however, with a home equity loan you can borrower much more if you have a lot of equity.
  • Easier Approval: Because you’re using your home as collateral home equity loans are usually easier to qualify for than other types of unsecured loans.
  • Tax deduction: Because the interest you pay on a mortgage is tax deductible you may be able to write off the interest you pay on your taxes. Speak to a tax advisor to see if you qualify.
  • Increase home value: The best way to use a home equity loan is to make repairs or home renovations that increase the market value of your home
  • Low interest rate: On average the rates given to a borrower for a home equity loan is approximately 5% which is lower than you will find for a personal loan, or other types of loans. Rates will vary depending on the lender.

Speak to Home Equity Lenders

Home Equity Loan Disadvantages

There are a lot of risks associated with home equity loans as well. These loans aren’t really intended to fund large unnecessary expenses like going on a vacation or buying a new car. Even paying off credit card debt is not always a good idea either.

  • Lose equity in your home: Obviously when you get a home equity loan you’re going to be losing the equity you have built up in your home over the years. Which is why it’s important to spend the money wisely.
  • Higher monthly payment: A home equity loan is a loan that you need to pay back monthly, although it is separate from your mortgage payment. Make sure you can afford the monthly payments before closing.
  • Secured debt: Remember, home equity loans are secured by your home, if for any reason you cannot make the payments you could face foreclosure.
  • Loan fees: There are closing costs and lender fees that are charged whenever you get a home equity loan or HELOC. These fees can be as high as they are when purchasing a new home, between 2-5%

Home Equity Line of Credit (HELOC)

A home equity line of credit, referred to as a HELOC, is another form of a home equity loan. You will use the equity in your home to get a line of credit, instead of a lump sum.

A HELOC loan works like a credit card, Lenders will extend a line of credit to you that you can borrow from whenever you need it. You will have minimum monthly payments based on the amount you’ve taken out.

Once you repay it, you can continue to borrow from the credit line. With a HELOC you’re only charged interest on the amount you borrow.

Who Qualifies

  • Mortgage must have at least a 70% loan-to-value ratio
  • 680 credit score or higher
  • Mortgage loan owed by Fannie Mae or Freddie Mac
  • Debt-to-income ratio of 41% or lower

Home Equity Loans vs Cash-Out Refinance

Both of these types of loans allow you to get cash by using the built up equity in your home. A cash-out refinance is different in that instead of having a second mortgage, your existing loan is refinanced and you are able to borrow additional funds up to 80% of the home’s value.

You will have one single loan with one monthly payment that covers your mortgage and the additional funds. Cash-out refinancing is usually easier to qualify for than a home equity loan because the lender is the primary lien holder on your home.

If you were to get foreclosed on, the primary lean holder is paid first and the secondary lean hold is paid whatever is left over.

If you have an FHA loan then mortgage lenders are unable to offer you a home equity loan. However, there is an FHA cash-out refinance loan available to homeowners with FHA loans.

Cash out refinancing, like other loans, will have closing costs and other lender fees to be paid at closing, however, these fees will usually be rolled into the loan.

Benefits of a Cash-Out Refinance

  • Easier to qualify for
  • Lower minimum FICO score required of 640
  • One monthly payment
  • Lower interest rate than home equity loans
  • Repaid over the mortgage term, lower payments

Home Equity Loan FAQ

Why do homeowners use home equity loans instead of other types of loans?

Homeowners can usually get a larger loan with a home equity loan because they can cash out up to 80% of the value of the property. Because they are secured by the home they can be easier to qualify for than a personal loan. Home equity loans also have lower interest rates than other types of loans.

What advantages are there of home equity loans?

The money can be used to make home improvements or repairs that will increase the value of your home. You can also use the funds to pay off high interest debt and get a new low rate to repay the debt much cheaper.

If you pay off your credit card balances you can improve your credit score significantly. The amount of available credit you’re using is called your credit utilization ratio which makes up 30% of your credit score.

What risks are involved with home equity loans?

These loans are always risky because your home is the collateral. When you get a personal loan it’s unsecured, if you run into financial issues and cannot make the payments your credit will be damaged and you may get sued, but you don’t lose any assets. If you’re unable to make your new higher loan payment, you risk facing foreclosure.

When is it a home equity loan a bad idea?

Your losing equity that you’ve built up in your home over the years so you need to be very smart about how you use the funds. Getting a home equity loan to fund a vacation or buy a new car is a big no-no.

You should save up for big purchases that are not related to increasing the value of your home or eliminating high interest debt.

When is it practical to take out a home equity loan?

The first thing you need is a stable career you’ve had for several years with consistent income. If you can check that box then a home equity loan makes sense if you want the money to make home improvements, repairs or renovations that will increase the value of your home.

Paying off high interest credit card debt is always risky but you limit that risk with consistent income. Paying off debt at interest rates above 15%-20% with a loan at 6-8% could potentially save you thousands of dollars is a good move as well.

Are home equity loans a good, or bad idea?

It really depends on the reason you’re needing the loan. If you’re seeking to pay off credit card debt I would recommend applying for balance transfer credit cards that offer a 0% interest rate for the first 12-18 months.

If you are just needing $10,000-$15,000 you should apply for a personal loan first to see what kind of rates your offered.