Home Equity Loan Pros and Cons
Home equity loans are borrowed to serve many purposes. Businessmen use the money borrowed to
expand their business. Many times, parents take home equity loans to pay their children fees. This type of loan is
useful especially for higher studies in a foreign country. Also, such loans are available at low interest rates
compared to those of credit cards.
What is home equity?
The term 'Home equity' is calculated by deducting the outstanding balance of liens from the actual market value
of the home. The actual market value of a property can be calculated by detailed research of the real estate
market. Home equity loans are also referred to as "second mortgage loans". However, there is a difference between
home equity loans and home equity line of credit (HELOC). HELOC does not have a fixed credit limit and the interest
rates are variable. On the other hand, home equity loan has a credit limit and is a lump sum amount with fixed rate
There are many things which banks/financial institutions consider before sanctioning a home equity loan. The credit
history of the loan applicant is studied carefully. The loan application may get rejected if it is found that the
applicant has not cleared his previous dues. Individuals with good credit history get preference while sanctioning
loans. Credit history can decide whether the applicant is credit worthy or not.
Types and pros of home equity loans
Banks prefer to forward loans by taking property as collateral. The reason for this is that if the borrower
defaults on the payments, the bank can recover its money by auctioning off the property. The process of applying
for these loans is simple and inexpensive. These loans serve the vital purposes of debt consolidation, medical
treatment costs and emergencies. The most striking advantage of home equity loans is that we can get a rebate in
income tax provided we produce all required documents. Along with sanctioning loan, the lender provides homeowners
insurance policy to the borrower.
There are two types of home equity loans. They are - closed end home equity loans and open end home equity loans.
In closed end HEL's, the loan applicant receives the entire amount at the time of closing. He cannot borrow any
money further. Closing is the last step in the execution of a real estate transaction. In some cases, banks
sanction loan up to 100% of the value of the home. The main point considered is the income of the applicant.
Stability of income assures the bank that it will get its equated monthly installments (EMI's) on time. Closed end
HEL's have fixed interest rates and have repayment period of 15 years.
In the case of open end HEL's, the borrower is free to choose when and how often to borrow against the equity. Like
closed end HEL's we can get loan equal to 100% of value of home. This loan has a repayment period of 30 years with
variable interest rates. The EMI's can be as low as only the due interest.
Cons of home equity loans
However, we should also consider the other side of the coin. There are certain cons of home equity loans. The
biggest loss to the borrower can be the permanent loss of ownership of his property if he defaults in the payment
of the EMI's. As the duration of the loan is high, the homeowner may face serious problems if the market value of
his home goes on declining. Sharp decrease in home prices is common during the phase of recession. To avoid this,
borrowers should think about their ability to repay. One should apply for a home loan only when he is financially
well settled. Elderly people should be well aware of the complications involved in repayment as they are nearing
retirement. Floating interest rates increase the EMI's by large amounts and disturb our monthly budget as the
monthly income is fixed. A businessman should have faith in himself that he will earn a decent profit on his
A home is a place where a person can find peace and solace after working hard throughout the day. Loss of this
precious thing may lead to severe depression and frustration in some people. So it is better to look (into the pros
and cons of home equity loans) before you leap.
Article Source and Author: Charlie S