Advantages and Disadvantages of a Home Equity Loan

By Meiling Hunter
Mortgage Credit Problems Columnist

You may be able to use the equity in your home as collateral for a sizeable loan to use as you please at a relatively low interest rate.

Advantages of home equity loans

• Potential tax deduction- Regardless on how you use the cash from your home equity loan-- home improvements or debt consolidation-- the interest that you paid on the loan is probably tax deductible -- check with a tax pro or the IRS Web site. Conversely, the interest you pay on your credit cards and unsecured loans is definitely not tax deductible.
• Lower interest rates- Since your home equity loan is secured by your home, it poses less risk to lenders than unsecured loans and credit cards. This reduced risk is passed on to you in the form of a lower interest rate. The lower rates on a home equity loans is particularly advantageous if you are trying to clean up bad credit by consolidating debt.
• Higher loan amounts -- Even if you have bad credit, you may qualify for a home equity loan for several thousand dollars. Unsecured loans and credit cards typically have lower limits and may not give you all of the cash that you need.
• Line of credit -- If you do not want to take borrow a lump sum you may be able to get a home equity line of credit (HELOC). HELOCs are a type of home equity loan, but resemble credit cards in that they have a set limit and you can tap into them at any time-- including day-to-day purchases.
  

Disadvantages of home equity loans

• Using your home as collateral -- If you are unable to make the payments on your home equity loan, you could lose your home.
• Membership or annual fees- This is only applicable to HELOCs. With HELOCs, you may be subject to additional fees such as annual fees, prepayment penalties, and transaction charges.
• Lost equity in your home -- When you borrow against your home's equity, you reduce the amount of equity or ownership in your home.
  

Should you tap into your home equity?

As attractive as home equity loans are, ask yourself if you should tapping into your home equity at all-- keep in mind that you put your house at the risk of foreclosure if you can't make the payments. Even though you may qualify for a home equity loan with bad credit, you should also consider if there are less expensive ways for you to borrow money -- do comparison shopping of home equity loans against unsecured loans and other sources of funds to see what is right for you.

Sources
The Federal Reserve Board
CNN Money

About the Author
Meiling Hunter has worked in the mortgage industry for four years. She graduated from the University of California, Davis, with a double major in Economics and Philosophy.

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