Pros and Cons of Home Equity Loans
Higher interest rates and rising home prices have kept many potential sellers from putting their homes on the market. However, in 2024, home equity lending hit its highest point since 2008. If you’re considering tapping into your home’s equity, it’s important to weigh the pros and cons of a home equity loan.
A home equity loan lets you borrow against the value of your home, using it as collateral. Unlike a home equity line of credit (HELOC), which works like a credit card, a home equity loan gives you a lump sum with a fixed interest rate and a set repayment schedule—perfect for one-time, big expenses.
How much can you borrow?
Typically, lenders will let you borrow up to 80-85% of your home’s equity. To figure this out, subtract what you owe on your mortgage from your home’s market value and apply the lender’s loan-to-value (LTV) ratio.
For example, if your home is worth $350,000 and you owe $150,000, with an 80% LTV ratio, you could borrow up to $130,000.
Pros of Home Equity Loans:
Predictable payments: With a fixed interest rate, you’ll know exactly what your monthly payments will be.
Lower interest rates: Since the loan is backed by your home, rates are typically lower than personal loans or credit cards.
Lump sum payout: Ideal for large, one-time expenses like home improvements or debt consolidation.
Flexible use of funds: You can use the money for virtually anything.
Tax benefits: If the funds are used for home improvements, the interest may be tax-deductible.
Boost your property value: Renovations could increase the value of your home, making your investment more worthwhile.
Cons of Home Equity Loans:
Risk of foreclosure: If you don’t repay the loan, your home could be at risk.
High upfront costs: Fees like appraisals and origination charges can cut into your loan’s benefits.
Increased debt load: Taking out this loan adds to your total debt.
Falling property values: A decrease in your home’s value could leave you owing more than it’s worth.
Long repayment terms: These loans can last 10-30 years, so they’re a long-term commitment.
Limited flexibility: Unlike a HELOC, a home equity loan doesn’t offer revolving credit, so once the money is gone, that’s it.
If a home equity loan doesn’t seem like the right choice for you, there are alternatives to consider, including HELOCs, cash-out refinancing, personal loans, or even reverse mortgages.