Part of being a homeowner is building equity, which is the percentage of your property that you have paid off and now fully own. Once you’ve paid off more than you owe, you may consider taking out a home equity loan to get money for anything from popular home improvements to starting a business. While this type of loan can be a good way to access a large sum of money at once, it doesn’t come without risks. Weighing the pros and cons is important with any financial investment, especially when your property is at stake.
How Does a Home Equity Loan Work?
When you borrow a home equity loan, your house becomes collateral. This means if you can‘t afford your payments, then you run the risk of losing your house. In order to qualify for this type of loan in the first place, you generally have to own 15 to 20 per cent of your property. So, if you’ve just purchased a house and only paid a year’s worth of mortgage, then you likely won’t qualify.
A loan can typically be no greater than 85-percent of your home’s total property value, which can fluctuate depending on the market and upgrades you’ve made. Renovations can boost equity faster, but they do come with the added cost of financing, which you might have to go into debt to pay off. If you get approved, you will receive a lump sum of money that has a fixed interest rate. You will make monthly payments in addition to your mortgage that allow you to pay off what you’ve borrowed on a timeline.
What About Lines of Credit?
You may not want to borrow a large sum of money at once but instead, have access to a line of credit whenever you need it. In this case, you could apply for a home equity line of credit (HELOC). HELOCs give easy access to cash on flexible repayment terms. You can review a guide covering everything there is to know about borrowing a home equity line of credit here. Credit over loans is often preferred by people who want access to funds but do not need them all at one time. Lower monthly payments also make them more favorable if you don’t need access to a substantial amount of money upfront.
What Are the Cons of a Home Equity Loan?
While they are easier to acquire than other types of loans, equity loans still come with their own drawbacks. For one, there is the fact that your house is put up as collateral. Should you run into financial hardship and be unable to make your payments, you risk foreclosure. Next, there are added closing costs that you will have to pay in addition to your regular payments. Lenders may also charge additional fees that are not included in your monthly payments. Lastly, borrowing equity means that you no longer own it. So, because you have put up the portion of your property that you own, it now belongs to the lender again until you repay your principal and interest in full.