Home equity loan pros and cons to know
As a homeowner, you're not limited to credit cards and personal loans when it comes to financing major expenses. You have an option not available to non-homeowners: tapping into the equity in your home.
There are several ways to do this, including home equity loans and home equity lines of credit (HELOCs). Home equity loans, in particular, can be especially useful for many large, one-time expenses, such as home repairs. But before you decide to take out a home equity loan, it's important to know the benefits and drawbacks of doing so. In this article, we'll break down the advantages and disadvantages of home equity loans so you can make an informed decision.
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Home equity loan pros and cons
Here's what you need to know when deciding whether a home equity loan is right for you.
Pros
Home equity loans can be an attractive option for many homeowners. Their benefits include:
- Lower interest rates: Interest rates on home equity loans are often lower than other types of loans. That's because your home secures the loan, making it less risky for lenders. This makes these loans especially appealing for consolidating high-interest debt.
- Fixed interest rates: Unlike HELOCs, which typically have variable interest rates, home equity loans have fixed rates. That means even if overall interest rates go up, your loan's rate will stay the same.
- Predictable payments: Because home equity loan rates are fixed, you know exactly how much your monthly payments will be. This makes it easier to budget for them.
- Access to a significant sum of money: Home equity loans can provide access to a sizable amount of funds, with some lenders offering loans of up to 85% of the equity in your home. This makes them suited for large expenses like unexpected medical bills or home renovations.
- Potential tax benefits: You may be eligible to deduct the interest you pay on a home equity loan if you use the funds for IRS-approved home improvements.
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Cons
While there are many advantages to home equity loans, there are also some drawbacks to bear in mind.
- Foreclosure risk: When you take out a home equity loan, you put your home up as collateral. That means you could lose your home if you can't make the payments. It's crucial to ensure you can manage the monthly payments before taking out the loan.
- Fees and closing costs: Home equity loans often involve fees and closing costs that can make the loan less attractive. These can amount to 2% to 5% of the loan amount. So, be sure to factor these in when weighing whether these loans are your best financing option.
- Lengthy repayment period: Home equity loans tend to have longer repayment periods than other types of loans, often ranging from five to 30 years. This means you'll be paying interest on the loan for a more extended period, resulting in paying more in interest than principal during the loan's early years. That said, stretching payments out could make monthly payments more affordable for you.
- Equity and credit score requirements: To qualify for a home equity loan, you must meet certain requirements. For instance, you'll need at least 15% to 20% equity in your home and a credit score in at least the mid-to-high 600s. If you don't meet these requirements, you won't be able to qualify — or, if you do, you won't qualify for the best rates.
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The bottom line
A home equity loan can be a cost-effective financing option for homeowners, but it's important to understand the pros and cons to determine if it's the right option for you. If the drawbacks make you hesitant, you have other options, including HELOCs, cash-out refinancing and reverse mortgages. Whichever option you choose, carefully consider your overall financial situation and how payments will fit into your budget to make sure you use the funds wisely.
