Home equity loans offer homeowners a way to tap into the value of their property, unlocking funds for big expenses or home improvements. They provide a steady stream of money with fixed interest rates, making it easier to plan for large projects. However, like any financial tool, home equity loans come with their own set of advantages and risks. In this guide, we’ll explore the pros and cons to help you decide if a home equity loan is the right choice for you.
See also: 17 hidden charges associated with home loans
What is a home equity loan?
A home equity loan lets homeowners borrow money by using the value of their home as security. It’s often called a second mortgage because it’s taken on top of your existing mortgage.
Here’s how it works: the amount you can borrow depends on how much your home is worth compared to what you still owe on your mortgage. For example, if your house is worth ₹50 lakhs and you still owe ₹20 lakhs, the difference, or equity, is ₹30 lakhs. You can usually borrow up to 85% of that equity, which means, in this case, you might get up to ₹25.5 lakhs.
These loans usually have a fixed interest rate, so your monthly payments will stay the same until the loan is fully paid off. You’ll get the loan amount all at once, and then repay it in equal monthly payments over a set time period, which can be anywhere from 5 to 30 years. But just like with your main mortgage, if you don’t keep up with the payments, the lender can take your home.
People often use home equity loans to pay for major expenses like home repairs, medical expenses, or school fees. However, it’s important to keep in mind that your home is on the line if you can’t repay the loan.
Read also: What is a home equity loan?
Why do homeowners consider it?
Homeowners opt for home equity loans for a variety of reasons. Many use the money for home renovations or upgrades, which can boost the value of their property. Others take advantage of the lower interest rates compared to credit cards or personal loans to combine and pay off higher-interest debts. Some choose to use the loan for paying college fees or covering education expenses. It can also help with large medical bills when unexpected health costs arise. People might use the loan to make big purchases, like buying a car or funding a wedding. It’s also useful to have as emergency money in case of unexpected financial situations. Some may use the funds for investing in another property or starting a business.
Types of home equity loans
| Type of home equity loan | What it is | Best for |
| Fixed-rate home equity loan | You get a fixed amount of money with a set interest rate and monthly payments. | Great for one-time big expenses like home upgrades or debt payoff. |
| Home equity line of credit (HELOC) | Works like a credit card. You can borrow and repay within a set time, usually with a changing interest rate. | Best for ongoing expenses where you need flexible cash access, like home projects or education. |
| Cash-out refinance | Replace your current mortgage with a new one for more than you owe, and you get the difference in cash. | Good for getting a large cash amount and possibly lowering your mortgage interest rate. |
Pros of home equity loans
Lower interest rates
Home equity loans generally offer lower interest rates than other types of loans, like credit cards or personal loans. This is because your home is used as security for the loan, reducing the risk for lenders. As a result, you can save a lot on interest payments over time, making it a cost-effective borrowing option.
Fixed interest rates
Many home equity loans come with fixed interest rates, meaning your monthly payments will stay the same throughout the life of the loan. This makes it easier to plan your finances since you won’t have to worry about changing payment amounts due to fluctuating rates. The stability helps you manage your budget better.
Large loan amounts
Home equity loans allow you to borrow a large amount of money, often up to 85% of the value of your home’s equity. This is particularly useful for covering significant expenses, such as home renovations, medical bills, or even paying for college tuition. It gives you access to the funds you need for bigger financial goals.
Tax deductibility
In some cases, if you use the home equity loan for home improvements, the interest you pay may be tax-deductible. This means that you could lower your taxable income, saving you money when it’s time to file your taxes. However, this benefit may not apply to all loans, so it’s important to check with a tax advisor.
Flexible use of funds
One of the best things about home equity loans is the flexibility. You can use the money for a variety of purposes, whether it’s consolidating high-interest debts, funding a business, or making large purchases. This flexibility gives you more control over how you address different financial needs.
Fixed repayment schedule
With home equity loans, you have a clear repayment plan. Since you know exactly when your loan will be paid off, it’s easier to plan long-term. This certainty helps avoid the uncertainty that comes with loans that have variable rates, allowing for better financial planning.
Potential for increased home value
If you use the loan for home improvements, you could boost the value of your property. This not only improves your living space but also increases the equity in your home. If home prices rise in your area, this could lead to a higher return on investment when you decide to sell your property.
Debt consolidation
A home equity loan can also be used to consolidate high-interest debts, like credit card debt, into one loan with a lower interest rate. This can reduce your monthly payments and make managing your debt easier, all while saving on interest costs in the long run. It simplifies your finances and helps you pay off what you owe faster.
Cons of home equity loans
Risk of losing your home
Since a home equity loan uses your home as security, missing payments can result in foreclosure. This means the lender could take your home if you fail to repay the loan. Additionally, if your home’s value drops and you owe more than it’s worth (negative equity), selling the house becomes difficult, increasing the risk of losing it.
High closing costs
Home equity loans often come with significant upfront costs. These include fees for loan origination, home appraisals, and title insurance. These expenses can reduce the amount of money you actually receive from the loan, adding to the total cost of borrowing.
Increased debt
By borrowing against your home, you’re adding to your overall debt. If your financial situation changes—like losing your job or facing unexpected bills—this extra debt can lead to financial strain and make it harder to manage payments.
Impact on your credit score
Taking out a home equity loan can temporarily lower your credit score, as lenders see it as a new debt. Missing payments can cause further damage to your credit, which may take time to recover from.
Limited flexibility
Unlike more flexible loans, a home equity loan comes with fixed terms and interest rates. If your financial situation changes, you can’t easily adjust the loan’s terms or payments to accommodate those changes, which could make managing the loan more challenging.
Emotional stress
Carrying the burden of a home equity loan can be emotionally draining, especially if you’re having trouble making payments. The pressure of knowing your home is at risk can add significant stress to your financial life.
Potential to owe more than your home’s value
If property prices drop after taking out a home equity loan, you could owe more than your home is worth. This can put you in a tough position, making it harder to sell your home or refinance the loan if needed.
When is a home equity loan a good idea?
Home renovations
Using a home equity loan to fund renovations can be a great idea if you’re looking to boost your home’s value. Whether you’re upgrading your kitchen or adding a new room, this type of loan can help cover the costs. Plus, in some cases, the interest on the loan might even be tax-deductible if it’s used for home improvements.
Debt consolidation
If you’re dealing with high-interest debt, like credit card bills, a home equity loan could help by consolidating all those debts into one loan with a lower interest rate. This can simplify your finances and reduce the amount you spend on interest, potentially lowering your monthly payments too.
Education expenses
A home equity loan can also be used to pay for education costs, such as college tuition. The interest rates on these loans are often lower than those for student loans, which can be a more affordable way to fund education. In some cases, the interest might be tax-deductible as well.
Medical expenses
When faced with large medical bills that aren’t covered by insurance, a home equity loan can provide the funds you need. Unlike credit cards, these loans usually have longer repayment terms, which can make it easier to handle significant medical expenses over time.
Financial stability
If your home’s value has increased, a home equity loan can offer cash without needing to sell your property. You can use some of this money to create an emergency fund, helping you cover unexpected expenses and maintain financial stability.
FAQs
The best choice depends on your individual needs and preferences. Consider factors like lifestyle, budget, commute, family, and amenities.
Lifestyle, budget, commute, family, amenities, safety, and quality of life.
Higher maintenance costs for older buildings, potential for noise pollution and traffic congestion in urban housing. Potential for higher property taxes in areas with good schools, higher costs associated with maintaining a larger yard in suburban housing.
The quality of life is subjective and depends on individual preferences. Some people prefer the excitement and diversity of urban living, while others prefer the peace and quiet of suburban living.
Crime rates vary between cities and suburbs. Some cities have higher crime rates than others, while some suburbs may have higher crime rates than others. Which is better, urban or suburban living?
What factors should I consider when choosing between urban and suburban living?
Are there any hidden costs to consider when buying a home in the city or suburbs?
How does the quality of life compare between urban and suburban areas?
Is it safer to live in the city or the suburbs?
| Got any questions or point of view on our article? We would love to hear from you. Write to our Editor-in-Chief Jhumur Ghosh at jhumur.ghosh1@housing.com |
