Pros and Cons of a Home Equity Loan

Home equity loans allow homeowners to borrow against the equity built up in their home. They come with both pros and cons, which are largely influenced by the reason they are utilized. Unfortunately, they were overused by homeowners whose property had an inflated value, and thus contributed heavily to negative equity when home prices fell. Anyone tempted to take a home equity loan should be aware of the consequences and weigh up the negatives, as well as seeing the initial gain.

Those who are well versed in finance and choose to use a home equity loan for investment purposes can often benefit by using their equity as a fund for future growth. This requires the future return to outweigh the increased costs of the mortgage interest which will be applied to the original loan. Savvy investors can use home equity loans as a down payment for a second home with rental opportunities, or as a good risk investment in stocks.

The reality is, though, that the majority of home equity loans do not lead to capital growth but reduction. They are primarily used for debt consolidation, vacations and home improvements. The latter is the only area where they offer a potential return if the property then increases in value enough to justify the loan.

Those who use home equity loans for vacations are reducing their current equity for short-term gratification at a high price. The cost of the loan represents expensive borrowing over the long term, which cannot be justified in financial terms.

Debt consolidation loans which reduce home equity more often than not end in default, and put additional pressure on those who are already struggling to cope with debt. It is never wise to convert unsecured debt into secured debt, as the risks of foreclosure are too high.

It is far better to come to arrangements with creditors or consider balance transfer cards to reduce personal unsecured debt than to put one’s home at risk. Most often those who utilize home equity loans for debt consolidation will face problems with future mortgage payments, and too often rack up further debt, having seen their debts reduced by borrowing against their equity.

Home equity loans do not come fee-free, and the price can be high. Where they are used to take advantage of a good investment they can be useful tools to utilize. The reality is that reducing one’s home equity is a bad move in general and risky, too. Homeowners are far better served by building up home equity, with the ultimate objective of becoming mortgage free.