Home equity loans - their advantages
If you're thinking about getting a home equity loan, you're probably aware that this is only one of the many financial instruments available to you. In fact, it has a lot of benefits over the competition, and in the following paragraphs I'll be analyzing the pros and the cons, explaining just what it is that makes a home equity loan a good deal, and how to make sure that yours is one of the stars and not one of the lemons.
Home equity loans can be better than refinancing
One of the choices available to you is as follows. On the one hand you could get a home equity loan in addition to your existing mortgage. On the other, you could refinance your existing mortgage, in a cash-out deal which would give you a lump sum. Both ways of doing it will increase the amount you owe, decrease the equity in your home, and give you a lump sum payment. But comparing the two can be very hard, and it isn't always obvious which gives you the better deal.
For a start, you can't compare rates directly. A 12% rate on a home equity loan could easily work out cheaper than an 8% rate on a refinanced mortgage. Understanding this perhaps counterintuitive fact is key to choosing between your options, and avoiding getting trapped in a deal more expensive than it looks. When you refinance, you are changing the interest rate on your entire mortgage. When you take out a home equity loan, you are only changing the interest rate on the extra bit you borrow. Supose you have a $200,000 mortgage at a rate of 6%. Now, you want an extra $5000, and you are offered refinancing at 8%, or a home equity loan at 12%. All the home equity loan will cost you is 12% of $5000 - that is, $600 per year. The refinancing, on the other hand, will increase your annual mortgage fees from 6% of $200,000 ($12,000) to 8% of $205,000 ($16,400). So the overall cost of the refinancing deal would be $4400, many times more than you would be paying with the home equity loan.
That's obviously a contrived example, dreamt up to illustrate my point. In particular, refinancing is likely to be very expensive for you at a time of high interest rates, but a better deal when interest rates are low. But you'll find a good many people seduced into refinancing rather than taking out a home equity loan, simply because they don't understand the high costs of refinancing compared to a home equity loan.
Home equity loans can be better than unsecured loans
It doesn't take much thought to understand that secured loans tend to be cheaper than unsecured loans. Take out an unsecured loan, and the lender has little way of being sure that their money will be repaid. You might leave town, you might go bankrupt, you might decide not to pay. And what can the lender do about it? Give you a bad credit rating, sure. Take you to court, even send the bailiffs round to your house. But with all this, they still run a much bigger risk of bad debt.
Conversely, if a loan is secured on your home the lender knows that you have good reason to keep up payments. If you don't, you're likely to lose your home - soemthing none of us would like to experience, and that will recoup most of the money that the lender put on the line. Since the lender is risking less, they can afford to give you a better deal.
All this is widely accepted. The cost is that you are risking your home - but if you are willing to do that, the benefits are substantial. And many people who could benefit from a home equity loan foolishly don't do so, instead keeping their money in expensive, high-interest unsecured loans.
If you have money borrowed on your credit card, or even from your bank in the form of an overdraft or unsecured bank loan, there is a good chance that you could improve your financial situation by taking out a home equity loan to pay off these unsecured loans. For the reasons I have just outlined, this is likely to save you a fair amount of cash.
Home equity loans for home improvements
A particularly appropriate niche market for home equity loans is home improvement. Suppose you are doing work that will increase the value of your home - building an extension, for example, or renovating a decrepit building. You would like to be able to finance this based on the increased value of your home following the improvement work. Some home equity lenders will allow this, using something called "Future Value Financing". What this means is that they will calculate how much your home will be worth after the renovation, and then they will make you a price quotation for a home equity loan based on that future value. In this situation, a home equity loan can be used to finance extensive work which you might have difficulty finding the money for from unsecured loans, even in a situation where you have limited equity in your house as it stands.
Now, let's summarise the arguments above. I've shown you that home equity loans may be better for you than refinancing your existing mortgage - or at least, that home equity loans tend to have lower hidden costs than some refinance deals. I've explained why home equity loans can give you lower interest payments than unsecured loans, at the small cost of slightly lower security. And finally, I've explained how you can use home equity loans to finance home improvements. Youcan read the other pages on this website to find some idea of the many options you have in selecting a home equity loan, and you can use the site to find some good bargains. I wish you all the best fortune in your hunt for a home equity loan that meets your needs.
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