About Home Equity Loan Pitfalls

A home equity loan can be a smart move for getting money using the equity within your home. Although the interest rate for home equity loans is usually quite attractive, you must always remember that tapping into the equity of your home opens up the potential to lose your home if you don't make your payments in a timely manner.

The Facts

A home equity loan is a loan that is secured by the equity within a home. Equity is the amount of money a house is worth minus the amount of money that is owed on the home. For equity purposes, any loan attached to the house is taken into consideration when calculating available equity. This means that an equity loan, equity line of credit, and first mortgage all reduce the amount of equity within a home. Interest rates for equity loans are usually much lower than interest rates for personal loans, and the interest paid on an equity loan can sometimes be tax deductible.

Risk Factors

A home equity loan is considered a subordinate mortgage. In other words, not paying your equity loan is essentially the same as not paying your primary mortgage. Missing payments on an equity loan can result in foreclosure. Some borrowers do not understand the importance behind keeping up with equity loan payments. They may think it's like any other loan and skip payments occasionally. Instead of this resulting in some calls from a collector, it can result in the loss of a home. Obtaining an equity loan also reduces the amount of equity within the home which can affect the homeowner's ability to be flexible with the asking price when selling the home.

Type

A home equity loan is always secured by the equity in a home. The two types are equity loans and equity lines of credit, both of which can be either fixed rate or variable interest rate. When borrowers choose variable interest rates, there is the potential pitfall of the interest rate going up, increasing the monthly payment. In some cases the payment can rise to where the borrower can no longer afford the monthly payment, putting them at risk of losing their home to foreclosure.

Time Frame

Another potential downfall to equity loans is that they may not be very quick to obtain. The application process is much longer than for a personal loan because in some cases the home must be appraised before the funds can be released to the borrower. Equity loans usually also have to go through a closing process similar to primary mortgages, which can also slow the process.

Expert Insight

Financial experts commonly disagree about equity loans. While some experts praise equity loans as great debt consolidation tools, other financial experts warn against using the equity in your home as a proverbial bank account. Experts who abhor credit generally dissuade homeowners from utilizing home equity loans.

Resources

• How to Understand a Home Equity Loan