What are Pros and Cons of Home Equity Loans?

  • Palak
  • August 26, 2023

Are you considering obtaining a loan to fund home improvements, consolidate debt, or cover significant expenses? Home equity loans offer an option for a substantial amount of money; however, there are pros and cons to weigh before getting one.

A home equity loan has its advantages and disadvantages – it can either be a great help or cause significant financial hardship. We wouldn’t want you to make the wrong decision, so let’s take a look at some of the pros and cons of taking out a home equity loan to help you make the best financial decision.

What is a Home Equity Loan?

A home equity loan enables you to borrow a specific amount of money that is then repaid in regular fixed installments over a period ranging from five to 30 years. The loan amount is determined by the percentage of the home you own outright.

Home Equity Loan Advantages and Disadvantages

Exploring the benefits and drawbacks of home equity loans provides valuable insights into leveraging homeownership for financial purposes.

10 Pros of a Home Equity Loan

Here are ten advantages of home equity loan to consider when evaluating a home equity loan: 

1. Fixed Interest Rate

If you obtain a home equity loan, the interest rate you have settled on will stay unchanged throughout the loan duration. This implies that your rate will not go up even if the Bank of Canada raises interest rates.

2. Lump Sum

You’ll receive the loan amount as a single lump sum, allowing you to access substantial money upfront for large expenses or investments. 

3. Lower Borrowing Costs

Home equity loans generally offer lower interest rates than other types of loans. This means that borrowing expenses may be reduced and there is potential for long-term savings.

4. Flexible Spending

You may use the funds from a home equity loan for a variety of purposes, such as:

    • home improvements
    • debt consolidation
    • education
    • unforeseen emergencies

This advantage gives you the flexibility to fulfill your individual financial needs.

5. Long Repayment Terms

Take advantage of extended repayment periods typically associated with home equity loans, allowing you to stretch out your loan payments over an extended period, leading to more affordable monthly installments.

6. Better Than Refinancing

Opting for a home equity loan can be a more cost-effective option when compared to refinancing since you can access funds without altering your existing mortgage terms, potentially saving you time and money.

7. Tax Advantages

You may be eligible for some tax benefits associated with home equity loan interest payments, depending on your particular circumstances.  If you want to know if you qualify for tax benefits on your home equity loan interest and understand the requirements, it’s best to speak with a tax professional. 

8. A Secured Loan

In a home equity loan, you use your home as collateral to obtain the loan. This can offer you more favorable loan terms, including higher borrowing limits and possibly lower interest rates.

9. Consistent Monthly Payments

Experience the convenience of consistent monthly payments with a home equity loan, allowing for better financial planning and budgeting as your payment amount remains unchanged over time.

10. Your Monthly Payments Won’t Change

Once you secure a home equity loan, your monthly payments will remain fixed throughout the loan term, providing stability and peace of mind unaffected by market fluctuations.

10 Cons of a Home Equity Loan

While there are considerable benefits to a home equity loan, you must also consider the home equity loan disadvantages:

1. Higher Interest Rate Than a HELOC

The interest rate for a home equity loan is generally higher than that of a HELOC due to the fact that home equity loans come with a fixed interest rate that remains unaffected by market conditions.

2. Your House Will Be Used as Collateral

A home equity loan involves using your home as collateral. This means that if you fail to repay the loan, you could lose your home. 

3. Closing Costs

Similar to a mortgage, home equity loans often come with closing costs, which can include:  

    • appraisal fees
    • application fees
    • attorney fees

All this adds to the overall expenses.

4. Two Mortgage Payments

If you have an existing mortgage, obtaining a home equity loan means you’ll have two separate mortgage payments to manage, potentially increasing your monthly financial obligations.

5. Lump Sum

Home equity loans provide funds as a lump sum, which may not be ideal if you prefer the flexibility of accessing funds on an as-needed basis.

6. Foreclosure

Failing to make timely repayments on a home equity loan can result in foreclosure, which means losing your home and facing significant financial consequences.

7. Significant Equity in Your Home

Homeowners with minimal equity may not be eligible for a home equity loan, as substantial equity in the home is usually required for eligibility.

8. Good Credit Score and Low Existing Debt

Lenders always need a good credit score and low existing debt to approve a home equity loan, making it essential to have a favorable financial profile.

9. Longer Application Process

In comparison to other types of loans, the application process for a home equity loan can be lengthier, involving documentation verification, appraisal, and underwriting. 

10. Fixed Interest Rates

While fixed interest rates provide stability over the loan term, they can also be a disadvantage if interest rates decrease in the market, as you would be stuck with a higher rate.

Do All Home Equity Loans Have Fees Associated with Them?

Home equity loans often come with various fees associated with them. These fees contribute to the overall cost of obtaining a home equity loan and should be considered when evaluating the financial implications.  While almost all costs can be incorporated into the financing, you must still understand the overall implication.  Fees may include:  

    • Appraisal Fee
    • Brokerage Fee
    • Title Fees
    • Lender Fees
    • Administrative Fees
    • Legal Fees
    • Title Insurance cost

Therefore, you must carefully review and understand the specific fees before pursuing a home equity loan. You may also talk to an expert mortgage specialist to discuss more.

What are the Alternatives to a Home Equity Loan?

Home equity loans are commonly utilized to finance various expenses, but they are not the sole choice available to you. If you are planning to borrow a substantial amount of money, explore these alternative options.

1. Home Equity Line of Credit (HELOC)

Similar to a home equity loan, your home’s equity secures a HELOC, and the amount you can borrow is determined by different factors such as:

    • your home’s value
    • credit score
    • debt-to-income ratio

While you can borrow the full credit limit immediately after closing the loan, the conventional approach with a HELOC is to borrow smaller amounts as needed.

Typically, a HELOC includes a 10-year draw period where you can borrow against your credit line, followed by a 20-year repayment period during which you must make fully amortizing payments of both interest and principal and borrowing against the credit line is no longer possible.

2. Personal Loan

The application process for a personal loan is often simpler, involving less paperwork and disregarding the amount of home equity available, with the possibility of approval and funds being received in as little as 24 hours.

However, unsecured personal loans may have borrowing limitations compared to home equity loans and generally have shorter repayment terms, although longer terms may be available for larger loan amounts.

3. Cash-Out Refinance

This type of refinance involves obtaining a new, larger first mortgage, with the proceeds being used to pay off your existing mortgage and cover closing costs, leaving you with the remaining cash to use as desired.

The advantage lies in having a single loan and monthly payment, with first mortgages typically offering lower interest rates than second mortgages, resulting in potential savings. Choosing a cash-out refinance may result in a longer mortgage term and ultimately lead to paying more in interest over time.

Key Takeaways: 

    • A home equity loan can be a great financial decision when used responsibly.
    • It offers considerable benefits such as potentially lower interest rates and the ability to quickly borrow a substantial amount of cash.
    • Careful financial planning and assessing your ability to meet the repayment obligations are crucial before getting a home equity loan.

Discover the Benefits and Drawbacks of Home Equity Loans – Explore Which One Best Fits your Needs!

Don’t let financial problems linger—seize the opportunity to achieve your goals and secure a stable future. Act now and make a lasting impact on your financial well-being. If you want to discover more about home equity loans and find the best one that suits your requirements, get in touch with us today.

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