If you own a home, then one way to free up extra money to consolidate debt or to make home improvements is to take out an equity home loan. A home equity loan is money that you borrow against the money you have paid towards your property. The amount you can borrow depends on the level of equity that you have, which is determined by your property value minus the amount you have outstanding on your mortgage. The equity is used as collateral to obtain a loan, which is basically a second mortgage. Rates on these types of loans are slightly higher than normal mortgages, but still low compared to other types of loans.
Why a home equity loan?
This type of loan has a number of advantages. Firstly, it can be used to get credit even if your credit rating is poor, because you are putting up collateral. Also, there are significant tax savings over normal loans as the interest paid on a home equity loan is tax-deductible. Also, you can borrow a lot more money than you usually can through an unsecured loan. You could use your this loan to consolidate your high interest debts, to make home improvements or buy other costly items. However, before you get a home equity loan you should look at the possible dangers involved, as some lenders can cost you a lot of money by not giving you all the facts. Here are some of the dangers of home equity loans:
Equity stripping
One problem that can occur with an equity loan is equity stripping. If you get a loan knowing that you cannot make the monthly repayments, a lender might give you the loan anyway. The lender is not concerned if you make the payments or not, as they can simply take away the equity in your home. To avoid this, be honest with yourself and only take out a loan that you know you can afford, even if you get offered more.
Balloon payments
If you are struggling with your current payments, then a lender might offer a loan at a much lower price than you are paying right now. This may seem attractive, but it usually involves a hidden ‘balloon’ payment at the end. Your payments are lower because you are only paying the interest back, but at the end of the loan term you need to pay the amount in full. This is likely to leave you in financial trouble and you may lose your home. To avoid this, make sure that you can easily afford your monthly payments, and if you do have to refinance make sure you can afford the final payment.
Credit insurance
One of the most costly aspects of this type of loan is credit insurance. You have agreed to a loan that is within your budget, but the lender then adds on extra features that you do not need, such as credit insurance. These items can significantly increase the amount you pay back, and often cover you for a minimal amount of situations. Before you sign anything, check that the terms are for the loan payments only, and not for extra insurance. If you do want insurance, you can usually find it cheaper elsewhere.
If you decide to get a home equity loan to consolidate your debts or free up some money, remember to look around for the best deals and to avoid signing anything that will cost you more money than you can afford.
Peter Kenny is a writer for creditcards-gb.co.uk.
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