Home Equity Loans: Pros and Cons
Ahh, home sweet home. You love everything about it . . . except maybe those windows that leak when it rains and the driveway that’s suddenly started to crumble and the dishwasher that no longer wants to wash dishes.
OK, so maybe your house could use some sprucing up – that’s where home equity can help. A home equity loan lets you borrow your built-up equity and put it back into your house to increase its value and your quality of life (goodbye, useless dishwasher).
You can use a home equity loan for lots of other purposes too (like consolidating debt, paying for a college education, starting a business or covering emergency expenses), but home improvements are probably the most common reason homeowners tap their equity.
Quick tip: To calculate how much equity you have, take your home’s current value and subtract your current mortgage balance. Here’s an example: If my home is worth $350,000 and I have $240,000 left on my mortgage, I have $110,000 in home equity. Ta-da!
It all sounds great, but is a home equity loan the right choice for your abode? Take a look some of the biggest pros and cons to help you decide.
Pros
- Great rates – Home equity rates are usually lower than personal loans or credit cards, making it a more affordable way to borrow.
- Steady payments – Home equity loans have fixed rates that won’t go up.
- Flexible uses – You can use your home equity for just about anything. (We’re not saying you should spend it on a giant indoor slide, we’re just saying you could.)
- Tax advantages – When you use your home equity loan for home improvements, the interest you pay is usually tax deductible.
Cons:
- Closing costs – Depending on the lender, you often have to pay some fees to finalize your loan, typically around 2% of your loan amount.
- Collateral – A home equity loan uses your property as collateral, meaning if you don’t repay your loan, you'll be at risk of losing your home. Yes, this sounds scary, but here’s the thing – if you don’t repay any loan, you’ll land yourself in hot water. Like any debt, take it seriously, create your repayment plan ahead of time, and don’t borrow more than you can afford.
- Requirements – To qualify, you'll need good credit and low existing debt. And while some lenders let you borrow up to 100% loan-to-value (LTV), most want to see 85% or lower. (To calculate your LTV, divide your mortgage balance by your home’s value. So, if I have $240,000 left on my mortgage and my home is worth $350,000, my LTV is .68 or 68%.)