Last week, we started analyzing some popular debt-based solutions, currently available to those homeowners who are looking into accessing equity in their home. On our last post, we focused on HELOCs and outlined some of the challenges and downsides that consumers may experience with home equity lines of credit. Today, we are going to dive into home equity loans, another well-known way to generate liquidity from the home. Finally, next week, we will be describing pros and cons of reverse mortgages.
Home equity loans – HELs – are secured by your house, as collateral, and allow you to borrow against your home’s value. The amount of the loan depends on the appraised value of the property. Differently than HELOCs, these loans allow you to take out a fairly large lump sum, according to the home value and your current equity in the home. Also, HELs are available as fixed or adjustable-rate loans and the time to repay the debt varies between 5 and 15 years. Many prefer a fixed rate solution in order to avoid unpredictable and unpleasant effects of rising interest rates in the future. Closing costs associated with the transaction are paid by the homeowner. These fees can be significant, but they are not as high as the ones you might have paid on your first mortgage.
This type of debt is usually selected by those homeowners who need liquidity for a specific large expense (high dollar renovation, medical, college tuition, etc.) or, may be seeking ways to consolidate debt. The advantage of a HEL is that the interest rates are lower than personal loans because you’re using your home as collateral. The downsides to using an HEL are that the approval is not guaranteed, and if the value of your home has decreased, you won’t be eligible for a home equity loan. The most important risk is that you’re pledging your home as collateral; so, if you are unable to make the monthly payments, the lender can foreclose on you, in the attempt to recover any unpaid funds and expenses. Finally, if you decide to sell your house, you still have to pay off the balance of the loan before the title can be transferred.
Ultimately, you have to decide whether a home equity loan is a good or bad choice. A responsible homeowner may very well provide for their financial needs through a HEL, and still maintain a balanced approach to their finances. That, in our opinion, is what matters the most: understanding the product you are getting and maintaining a healthy balance. One big challenge, however, remains. By adding a second mortgage of either type, you are further going into debt. It means that you will have an additional monthly amount to pay, or a periodic installment to make, and you will pay interest charges. Borrowing against your home may seem attractive but homeowners may mistakenly see this financial behavior as a source for a better lifestyle, disregarding the risks and the true costs of debt. Next week, we will review the last and possibly most controversial debt option for homeowners: reverse mortgages. We will see how this debt solution works, the positive aspects, as well as the pitfalls. Hopefully, we’ll see you here for another great discussion!