The Pros and Cons of a Home Equity Loan
Casey is a reformed sports journalist tackling a new game of financial services writing. Mike Francesa once called her a “great girl.”
At a Glance
Home equity loans can be beneficial in certain circumstances. Take a look at the pros and cons of a home equity loan to see if applying for one makes sense for you.
Advantages of A Home Equity Loan
- Easier to qualify for than a personal loan because it’s secured
- Receive the loan as a lump sum
- Use the money however you’d like
- Interest payments may be tax deductible if money is used for home improvements
- Fixed interest rates and consistent monthly payments
- Easy to predict and budget for
- Can be used to consolidate debt
- More affordable than private loans
Disadvantages of A Home Equity Loan
- Puts your home at risk of foreclosure as collateral
- May not net as much if you sell your home because you still have to pay the balance of the loan
- Possibility of going “underwater”1: If the value declines, you could owe more than your home is worth
- Interest rate and total payment will be higher with bad credit
- Long-term fixed rate debt payment
- Two mortgages instead of one
- Closing costs and fees
- Bottom line: You’re taking on debt
Alternatives to Home Equity Loans
There are other options to consider if you need cash but find that a home equity loan isn’t right for you.
A HELOC, or home equity line of credit, provides you with a line of credit based on the value of your home. So, you can borrow what you need when you need it, and repay the funds over time. Besides a credit limit, HELOCs usually have a “draw period,” or a set amount of time when you can use the line of credit.
Like a home equity loan, a HELOC is a secured loan because the equity in your home acts as collateral. You could risk losing your home if you default on a HELOC.
With a cash-out refinance, instead of taking out a second mortgage, you rework your existing mortgage to be higher. You then use the loan to pay the original mortgage and keep the difference.
You may be required to have at least 20% equity in your home to qualify for a cash-out refinance.
While it may be easier to qualify for a cash-out refinance, it may not be the best bet in the long run. Depending on when you bought your home and when you refinance, you could wind up paying more in interest. To refinance, you’ll also deal with fees and closing costs.
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