Home equity loans typically offer very attractive rates for borrowers in need of cash for home improvements or for just about any reason. If used responsibly with a focus on payback, a home equity loan can be a great benefit. If taken lightly, however, a home equity loan can also pose some risks. Home equity loans enable homeowners to borrow against the equity in their homes. Simply put, a home is put up as collateral for the loan. When a home is used as collateral, there is jeopardy of losing it if the loan is not paid. That’s the biggest risk, but not the only one.
4 risks of home equity loans
1 Home foreclosure
As we just mentioned and not trying to scare you out of borrowing but failing to repay a home equity loan can do more than just damage your credit rating. It can result in the loss of your house. That’s the biggest risk of borrowing against the equity in your home. How can you avoid this? Make all of your monthly payments on time. Home equity loans are best for responsible borrowers, and not to be taken lightly by others looking for a quick cash fix.
2 Getting stuck with the wrong type of home equity loan
There are home equity loans and home equity lines of credit (HELOC). They are similar, yet different. Not understanding the difference between the two can turn into a big risk for a borrow. Both enable you to tap into the equity in your home for a loan. A home equity loan provides the borrower with a lump sum of cash all at once at a fixed interest rate with a fixed repayment schedule. A HELOC, on the other hand, is a revolving line of credit with a variable interest rate. You are approved for a credit line limit and you draw the money as you need it during the draw period. During this time, you make only interest payments. The draw period could be five years or more. The rate of interest is adjustable, so it may fluctuate over time. After your draw period ends, you can no longer draw on the line and must begin a pre-set repayment period. By this time you may be comfortable with that low, interest-only payment and in shock when you realize the amount of your new payment.
A home equity loan is a more structured option for someone looking for a predictable monthly payment. As we touched on above, a HELOC may catch you by surprise when the repayment period starts. You may not have planned well or budgeted properly. You may be in a different financial situation than when you first applied for the HELOC. How do you avoid this danger? Speak to a Choice One Credit Union lender and your homework in advance on the best type of home equity loan for your needs. If you do decide on a HELOC, make sure you plan your budget out so when the repayment period begins, you have the funds to make your payments on time.
3 Borrowing more than you can afford
An over-eager lender may push for you to borrow more than you actually need or that you can afford. Different lenders will allow you to borrow different percentages of the equity in your home. Although you may have enough equity to borrow $50,000, you may only need and want $20,000. An over-zealous lender may try to talk you into borrowing the entire $50,000. If it’s not the amount you planned on, your budget may be in big trouble, and you may find yourself drowning in debt. Prevent this from happening by only borrowing what you need and can afford. Deal only with reputable lenders.
4 Racking up even more debt
For some, home equity loans are a good means of consolidating high-interest credit cards and other debt. Done conscientiously, this can be a good option. Taking out a home equity loan to pay down debt, then turning around and maxing out your credit cards again will leave you in double trouble. It’s irresponsible and puts your home in jeopardy. Never use a home equity loan to bankroll a lifestyle you can’t afford. Avoid using the funds for elaborate vacations, shopping sprees or expensive toys. More appropriate uses for home equity loans include home remodel and home improvement projects, debt consolidation and big-ticket life events like a wedding. Make smart choices with your spending and avoid the risks of home equity loans.
Finding the right home equity loan
Finding a good home equity loan means comparing more than just rates. You want to find a loan with low or no fees, no pre-payment penalty, and flexible terms. Shop around and find a home equity loan lender you can trust. Your local credit union is always a smart place to look. At Choice One Community Credit Union you’ll always receive friendly personalized service. Visit us online to learn more about our home equity loans and home equity lines of credit or to view our rates.