Home » Pros and Cons » 12 Home Equity Line of Credit Pros and Cons

12 Home Equity Line of Credit Pros and Cons

Are you thinking about a second mortgage? That’s essentially what a home equity line of credit happens to be. Instead of receiving a lump sum, however, you’re given a credit line that can be used for any purpose. It isn’t available to new homeowners because they haven’t paid down their principal on their mortgage enough to qualify. That’s what equity is: how much of the house you actually own compared to its value.

There are some key advantages and disadvantages to be considered here. Keep these in mind before finalizing a decision on your monetary needs.

The Pros of a Home Equity Line of Credit

1. The line of credit is backed by real collateral.
Unlike signatory debt, which is backed by nothing more than a promise to repay, a home equity line of credit is backed by the security of a home’s value. This means there is something a lender receives in return should a default on this line of credit occur. Because the house guarantees the credit, the interest rates are typically lower on this debt, even if credit scores are lower.

2. It can help to pay one-time expenses.
Although a home equity line of credit doesn’t make sense for all debts, the massive one-time expenses families may face could have it make sense. Instead of funding a college tuition through student loans, for example, this line of credit could cover most, if not all, of the costs of higher education.

3. It gives you plenty of flexibility.
You can borrow as much or as little as you wish up to the limit that is established by the lender. This reduces the fixed monthly payments that a home equity loan would normally require and provides some added payment flexibility when it may be needed. In many ways, this line of credit is more like a credit card in how it is ultimately used than it is a mortgage. You have to pay the interest that is due, but you may not be required to pay down any principal with each payment over the life of this line of credit.

4. It can help you consolidate debt quickly.
Many large balance loans have high interest rates associated with the principal that remains outstanding. Because a home equity line of credit is secured and has a lower interest rate, it can save homeowners thousands on various types of debt. If you get $125k at 3.15% and you’re paying a $60k student loan at 6.8%, that is savings which will add up quickly every month.

5. It can provide a cash reserve in an emergency situation.
If a job is unexpectedly lost and there is no income expected in the near future, the home equity line of credit can become a cash reserve to help cover the gap between jobs. Although there is some risk in doing so because the credit could be canceled by the lender, it can be used to pay for medical care, basic needs, or other unexpected requirements in an emergency.

6. There is ongoing flexibility.
The line of credit will be there to use it as often as needed. The balance can be paid off and used again. For a home equity loan, on the other hand, one lump sum is given with repayment in structured amounts expected.

The Cons of a Home Equity Line of Credit

1. You need to have a stable income for it to work.
Although you might quality for this line of credit, it may not be the best debt solution for you. If your income isn’t stable or it could change in a negative way while the debt is outstanding, then other forms of funding must be considered. If you miss payments on a home equity line of credit, you can be foreclosed upon.

2. Your lender can freeze your line of credit.
If the value of your home reduces for some reason, even if that reason is outside of your control, then it is possible for lenders to freeze the credit so that it can no longer be used. It won’t force you out of the house, but whatever debt you did create through the line of credit must be repaid or that could happen. Even if a lender thinks you might be a higher risk line of credit than initially thought, they can still freeze your credit.

3. There are numerous costs that are charged upfront.
Remember all of the fees that were paid when you got a mortgage? Those fees come back again with a home equity line of credit. The only problem is that most lenders won’t roll the charges into the loan amount like they may with a mortgage. From the application fee to the points on the line of credit, there could be thousands in charges headed your way.

4. Most home equity lines of credit are not fixed-rate.
You’ll often be stuck with a variable interest rate when agreeing to this type of credit. These loans with adjustable rates have lifetime caps that set a maximum interest rate, so you’ve got to be prepared to pay that maximum rate should it occur. If you look at your finances and realize that you won’t be able to pay that amount, then this line of credit isn’t right for you.

5. The line of credit may be considered additional income on your taxes.
This depends on how the home equity line of credit is used. If you take your credit and pay off a vehicle loan, a credit card, and take a vacation with it, then you may need to claim those costs as additional income on that year’s tax return. If you take a home equity line of credit and use it toward home expenses, however, it may not need to be reported as income. Always consult your tax advisor about your specific financial situation.

6. The entire principal amount may become due on the line of credit.
Let’s say that a family takes out a $30,000 line of credit. They’re used to making monthly payments, so they pay the amount due that is shown on their billing statements. The only trouble is that the amount due reflects the interest that needs to be paid on the outstanding debt. If they spent all $30k and only made the minimum interest payments, when the draw period is over, the entire balance could be called. Not paying it could threaten the home.

The home equity line of credit pros and cons show that this type of debt isn’t for everyone. It could be right for you, however, if you have some large expected expenses coming up. Weight the pros and cons carefully and you’ll be able to tap into your home’s equity with the best rate possible so your financial needs can be met.

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