A home equity loan is a very popular financial product chosen by homeowners who have collected some equity in their homes over time. This loan can be used for an array of uses like home expansions, improvements, or even repairs. However, as all kinds of other loans, home equity loans also come with a variety of advantages and disadvantages which borrowers need to be aware of before choosing home equity loans. In this article we will discuss the various pros and cons of these loans.
How Do Home Equity Loans Work
As established previously, a home equity loan can be taken by homeowners, either individually or with a co-signer against the equity that they hold in the said property. This requires knowing how much equity the borrower has in the property.
To calculate how much equity a borrower has in the house, a current appraisal of the property is required to find out its latest market value. From this value, the amount of mortgage balance that they have left to pay is subtracted to come up with the dollar value of equity they hold. Furthermore, the equity amount that they hold is divided by the value of the house to determine the percentage of equity that they hold.
After the equity value is known, the borrowers can proceed with the application to get the loan approved. It is generally advised that the borrowers not seek a loan of greater than 80% of their equity value. This loan is typically offered with fixed terms and a fixed rate of interest. In accordance with these terms, the borrower has to start the repayment of the loan which lasts a specified period of time.
A home equity loan is typically granted against the equity that the borrower holds in the house, and the house itself can be used as collateral for its approval. In the event the borrowers fail to pay the loan off, the lenders can begin a foreclosure process, and even possess the house to make up for their loss.
Pros And Cons Of Home Equity Loans
Home equity loans come with their own pros and cons which may be variously applicable to different borrowers. It is imperative for the borrowers to be aware of these factors and assess them in light of their particular standing to understand how useful the loan can be for them.
Pros Of Home Equity Loans
Some of the main advantages of home equity loans include the following.
Quick Cash
A home equity loan can be quickly processed which means that borrowers get access to the loan amounts quickly and as such, can use it for whatever use they need rapidly. Moreover, the loan is provided in a lump sum amount which means that the borrower can plan big purchases or expenses without having to worry about how to afford them. Since these loans are disbursed straight to the borrower, its usage becomes even more simple and accessible by the borrowers.
Lower Rates Of Interest
As compared to other loan options which homeowners may choose and secure, a home equity loan is available to them at a much lower rate of interest. This means that the overall amount of money that they need to repay in addition to the principal sum when repaying the loan, is significantly lower than other options.
Versatility
One of the most significant pros of a home equity loan is that these loans are highly versatile. This means that the borrowers can use the loan amount for any purpose, whether related to the home or otherwise.
A home equity loan is commonly used for home improvement projects, however, it can be used to meet other expenses as well. Contrary to some loans which can only be used for specific loans (like home mortgage, auto loan, etc), these can be used as the borrower wants.
Fixed Terms
Another critical advantage of home equity loans is that they come with fixed terms. This includes a fixed rate of interest and a fixed period of time over which the loan has to be repaid. Because of this feature, the borrower has the ability to easily plan out their future finances, which includes planning any big expenditures and purchases, as well as planning savings and investment options.
Improving Credit Score
Given that home equity loans are simple to get, they can help the borrowers in improving their credit score significantly. To achieve this, the borrowers need to make sure that they repay the loan on time, and do not miss any installments.
Cons Of Home Equity Loans
Some of the main cons of home equity loans include the following.
Eligibility Criteria
At times, a home equity loan can have some very difficult eligibility parameters which a lot of borrowers may find challenging to fulfill. The debt-to-income ratio of the borrower is one of the primary aspects which are taken into account along with the borrower’s financial records and credit history.
If the minimum requirements are not met by the borrower, the loan may be declined by the lender. However, different lenders can have different requirements, and borrowers can approach multiple lenders.
Risk Of Losing Home
Another major downside of a home equity loan is that failure to repay the loan by the borrower can trigger the lender to initiate foreclosure processes. When this happens, the borrower risks losing the house which in a lot of cases is taken as collateral.
Additional Charges
There can be a lot of extra charges and fees associated with a home equity loan. These can include things like fees for property appraisal, application charges, penalties for late payments, loan closing expenses, as well as upfront fees. These vary from lender to lender, so borrowers need to inquire about these beforehand.
Conclusion
A home equity loan can be a very useful financial instrument based on the requirements of different borrowers. This loan, also known as a secondary mortgage should be carefully opted for, only if needed to prevent oneself from spending unnecessarily and losing the house. Timely repayments are a must to secure your credit score, and the house.
