Pros and Cons of a Home Equity Loan

Home equity loans represent one of the ways to utilize the unrealized market value of one of your best assets – your home. Equity, in this context, is the difference between what you owe on the property and its valuation. As the mortgage debt is reduced and the property value appreciates, the difference can be a significant amount. Without the home equity loan – or home equity lines of credit – the only way to access this equity would be to sell the house. That is the primary advantage of home equity loans. However, there are many other merits and demerits to consider.

== Pros ==

♦ Debt consolidation

The large reserves that home equity provides make it a great way to consolidate smaller debts. Unsecured debts, like credit card balances and small consumer loans, have higher interest rates. The home equity loan, being a secured loan, has lower interest rates. The amount of home equity typically available makes this type of loan ideal for debt consolidation.  In addition to the single payment and lower interest rate, debt consolidation through home equity loans yields tax benefits.

♦ Emergency fund

Not everyone has a sizeable liquid cash reserve for emergencies and hefty medical expenses; persons might be living in their emergency fund. A home equity loan might be the option to take, instead of paying by installments (with interest).

♦ Low rates compared to home equity credit lines and credit card loans

Home equity credit lines provide an alternative means of tapping into equity. That option has variable interest rates, although it is far more flexible. A home equity loan provides a lump sum upfront, with a stable repayment rate. Generally, home equity loans are preferable to credit card loans because they are safer and cheaper.

♦ Income tax rebates

Mortgage interest payments are a common tax deductible. The only demerit of this advantage is that there are limits to how much you can claim within a period. If the home equity loan was used for home improvements, the tax deductible is even higher.

♦ Homeowners’ insurance

It is easy to have your property underinsured as its value steadily appreciates. Lenders often ensure that homeowners have adequate coverage and facilitate this protection as well. The revaluation of your property is a great opportunity to adjust that coverage, even if you have a homeowners’ policy in force already.

== Cons ==

♦ Risk of decline in the value of the property

One of the problems with the home equity loan is that you might owe more than the home is worth. The likelihood of this happening might not be so far-fetched. Property values can decline sharply for macroeconomic reasons (recession) and microeconomic reasons (neighborhood problems). What the property devaluation does is make the home equity loan virtually unsecured; it wipes away the safety net and security of collateral.

♦ Using the property as collateral

That the home equity loan is secured makes it a lot cheaper than other options. However, there exists the possibility of loss of home ownership if payments on the loan are defaulted.

♦ Penalties for early repayment

Some home equity loans that have lower interest rates than other home equity loans might have prepayment penalties. Fortunately, not all home equity loans have this penalty, but it is important to know the amount of the penalties. If you would like the option of paying off your loan earlier, prepayment penalties should be avoided.

♦ Balloon home equity loans

Balloon payments on home equity loans offer the mortgagee the option of paying interest only until the end of the loan. The demerit of this is the higher risk of defaulting. Not having the finances to schedule payment of the capital during the amortization period demonstrates financial hardship. Often, there is no guarantee that the mortgagee would have the money later either.

♦ Loan fees

Home loans have a number of fees associated with them. These include, but are not limited to, appraisal fees, originator fees, and title fees. Such fees are included in the cost of the loan, increasing the balance owed and mitigating the benefit of accessing equity.

The benefits of the home equity loan must be carefully weighed against its demerits in the context of your financial circumstances. It is particularly important to assess your own future financial circumstances, and that of the economy, before deciding whether to take it or not.