For most people, a home is their biggest investment and most valuable asset. As such, it's natural to consider tapping into the equity you've accrued when financial needs rise -- as they inevitably do.
What's less certain, however, is whether seeking a home equity loan or home equity line of credit is the best decision for your particular situation.
In order to make the appropriate choice, potential borrowers should carefully weigh the pros and cons of tapping home equity.
Home equity pros
Competitive interest rates are one of the primary advantages of a secured home equity loan. Generally speaking, these loans will cost you less in interest payments as compared to a credit card or personal loan, as the home acts as collateral. Unsecured loans (no collateral) will typically have significantly higher rates.
For this same reason, credit qualification is often easier with a home equity loan. Borrowers with less than perfect credit may find that a secured equity loan is their best (or only) option.
Interest on home equity loans, much like a mortgage, is generally tax deductible. Borrowers should be aware that there are limits placed on these deductions, however, based on how the borrowed funds are used.
Home equity loans also offer longer repayment terms and predictable payments. Borrowers can take advantage of low monthly payments and rest assured in the knowledge that these payments will not fluctuate, allowing them to budget with confidence.
Home equity cons
While the benefits listed above are certainly attractive, it's important to be diligent when researching any loan. In the case of home equity loans or lines of credit, there are some important considerations of which to be aware.
The most serious drawback to borrowing against your equity is the potential of a foreclosure if you default on a secured loan. While this type of loan offers better rates, you run the risk of losing your asset. The foreclosure process starts with missed payments. Once you have failed to make on-time payments for a certain period (typically 3-6 months), your lender may then continue the foreclosure process, which could eventually result in you losing your home.
Home equity lending products are also often too large for a borrower's needs. If the amount of money you require isn't substantial, the home equity process may be too time-consuming. Additionally, lenders typically have minimum borrowing amounts for home equity lending products.
Finally, because the amount of money borrowed tends to be significant, you will have to resist the temptation to overspend, or pursue projects that aren't priorities.
Home equity loans and lines of credit offer a variety of positive benefits, but borrowers should also remain aware of the drawbacks. Please visit the Home Equity section of our website for information about equity-based lending products.