Pros and cons of home equity loans

Home equity loans are a popular way for many homeowners to reinvest in their homes, pay off other debts, or make other major purposes. While it may be tempting to cash in on the equity in your home, there are a number of pros and cons to these types of loans.

How much equity is in my home? 

There are a number of factors that contribute to how much equity you have in your home.

  • Down payment. The larger the down payment you made when you initially purchased your home, the more equity it will have.
  • Life of the loan. The longer you have been paying down the principal on your loan, the more equity your home has accrued.
  • Current market value. If the current market value of your home is worth more than what you owe on your mortgage, your home has positive equity.

Pros and cons of a home equity loan

If you need to borrow money, there are a number of advantages to taking out a home equity loan. The following pros and cons can help you make a decision as to whether or not this type of loan is right for you:

PRO: Lower interest rates. Home equity loans tend to have lower interest rates than other types of consumer credit, such as taking out a personal loan or borrowing against a credit card.

CON: Risk of foreclosure. Because the equity in your home serves as the collateral for the loan, if you default on the loan you could lose your home and face foreclosure.

PRO: No restrictions on how you use the loan. Most loans must be for a specific purpose and the money from those loans must be used for specific things. Home equity loans do not include restrictions on how you use the money; popular uses of home equity loans include paying for vacations, new cars, college tuition, weddings, or home improvements.

CON: Additional costs and fees. Taking out a home equity loan can incur various fees, including closing costs. This can make the loan more expensive at the outset than other types of credit.

PRO: Loan is tax deductible. If you use a home equity loan to buy, build, or improve your home, the interest can be tax deductible up to $750,000.

CON: Potential mortgage recording tax. In some areas, homeowners must pay a mortgage recording tax in order to take out a home equity loan. Taxes are often based on the loan amount; the more you borrow, the more in taxes you have to pay.

Home equity loans can be a valuable financial tool – but they do involve risks. Weighing the pros and cons of taking out this kind of credit can help you make the right financial decision for your family!

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