Pros and cons of home equity loans

What is a home equity loan?

Practically, a home equity loan is a secured loan. As a simple explanation, the equity represents the difference between the amount owed with your mortgage and how much your home is in worth.
For instance, if the mortgage is for $100,000 and your home is for $150,000, then you may take a loan for the remaining amount of $50,000. The additional value of your home means exactly the security on your loan – the home equity loan.
Sometimes, home equity loans are called second mortgages and are very popular with homeowners. In 2005 there was cashed out around $204 billion in home equity loans in the USA.

Things to take care of when applying for a home equity loan

If you intend to pay off the home equity loan too early, some loans get steep penalties and a typical penalty is the 10 percent of the total amount that has been borrowed. You have to make sure it does not exist any penalty enforced by the lender to prepay your home loan. You must take care to loans whose interest you are paying monthly and which are then hit with a huge payment up to the end of the loan term – so called the “balloon loans”. Try to avoid them.
Remember, you have the legal right your loan to be cancelled within 3 days of taking the loan out, and all the application fees and/or any additional charges will be back to you.

Advantages of home equity loans

Speaking about advantages, here can be distinguished the tax benefits that are really significant with this type of loan. The interest paid on the equity loan may be tax-deductible while the closing costs and all additional fees for the loan are paid or can be rolled over into the loan itself. In order to avoid mistakes, try to consult with your tax advisor. The interest rates on these loans are competitive because of the reasons above.
You can pay off the loan in a short period of time if you have many plans. Rather than just paying the min. payment, you can pay more to the principal - just like you can do with your mortgages. The cash obtained from loan can be used for whatever you need: Holidays, home improvement, college tuition costs etc… All these are popular justifications why it’s recommended to take off a home equity loan.

Disadvantages of home equity loans

You get the risk to lose your home if you cannot make the monthly payments on a home equity loan and this is just as with the actual mortgage. If the value drops too much, you may finally owe more on your home than it is actually worth. If you intend to get a career change and a possible lower income due to the situation, then a home equity loan is not the right choice.
The home loan has also associated some fees and various charges when taking it out and these amounts can be incorporated into the total loan amount. These charges usually include the home appraisal fee, the property application fee, the title fee and several taxes related to your mortgage.

And finally, one but not the last thing you may want to consider is a home equity line of credit rather than a home loan because the main advantage is: you are paying interest on the amount you use. For example, if you have a line of credit of $10,000 but you only use $4,000, then the interest must be only paid on the $4,000.