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Are Home Equity Loans a Good Idea?

 Legal paper displaying “home equity loan” on desk alongside calculator, cash and glasses

If you’re considering a home equity loan, you should give some serious consideration to the real costs of this kind of loan.

The Basics of Home Equity Loans

A home equity loan borrows against the value of your home. So, it doesn’t improve the value of your home or your current financial situation (outside of having access to cash). There are two types of equity loan—a lump-sum loan and a line of credit.

There is one great risk that many overlook when opting into a home equity loan. The equity that secures this loan is your home. If you can’t make the payments, you put your home at risk. Be aware that foreclosure is a possibility.

Most people take out equity loans for major projects like a home renovation, and these loans are rarely small. Many banks and lenders won’t distribute an equity loan of less than $10,000.

For all intents and purposes, these loans are treated like mortgages. Their interest rates are usually higher than the average mortgage rate but can be attractive, as they’re often still lower than standard market rates for unsecured loans.

Are Home Equity Loans a Good Idea?

There may be some situations where you can profit from taking out a home equity loan. If you’re looking to increase the value of your home investment through repairs or renovations AND you intend to sell the home for a profit, you could make enough money to pay both the mortgage note and equity loan in one sweep while generating some extra money from the sale. This doesn’t work in every case. Your chances of coming out ahead depend on several factors:

  • Size of the loan
  • Amount you owe on your primary mortgage
  • Real estate market in your area
  • Quality of the home and its upgrades

Obviously, there are a lot of variables here, and this indicates a level of risk. There is a level of risk involved with taking on debt secured by your home as collateral.

When Home Equity Loans are a Bad Idea

Depending on your stance regarding debt, a home equity loan could always be a bad idea. Disregarding the question of whether there’s good or bad types of debt, let’s focus on the kinds of situations wherein you’d consider a home equity loan.

You’re taking out a loan because you “need money.”

This doesn’t solve your problem. It only treats a symptom. The real solution isn’t a loan. It’s a shift in your behavior regarding money. Of course, this isn’t a one-size-fits-all statement. There are occasions when taking on debt is inevitable— i.e., you have no savings and incur an expensive medical bill or car repair. The point is, “needing” money isn’t a problem that can be solved by simply taking out a loan.

You’re underwater on your mortgage.

If you owe more than your house is worth, you’re “under water.” If this is your situation, taking on more debt just increases the amount you ultimately owe on your property. To compound the issue, the collateral for that loan is the property in question.

Your debt-to-income ratio is high.

Just because a lender agrees to let you borrow money doesn’t make it a good idea. Before you take out any loan, you should consider how easily you can make the payments. If you’re spending your loan money on something that doesn’t generate value, you’ll just be spending more money per month out-of-pocket.

If you’re in a difficult financial situation, now may be the time to consult a professional about your debt problems. If your obligations to creditors are weighing on you, CreditGUARD can help with its non profit debt management solutions. Call CreditGUARD Today to speak with a certified credit counselor who can help you take the next step toward a better financial future.