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Loans drive the economy. Regardless of one’s economic status, most people do not always have all the money they need to buy the things they want. Whether it is a home, a car, a new business or something else, the ability to take advantage of credit is what keeps the economy flowing. One way to get a loan for the things one needs is by borrowing against the equity in one’s house. This is called a home equity loan.

What Is a Home Equity Loan?

A home equity loan is simply a loan that you borrow against your house. Essentially you reduce the equity in your house by borrowing some of the money you have already paid into the mortgage. The traditional home equity loan is a second mortgage, which is a new mortgage that covers what you still owe on the home plus the amount you wish to borrow. A home equity loan is distinguishable from a home equity line of credit (HELOC) in that the first is a lump sum amount that you borrow while the second establishes a line of credit that you can borrow against. The advantage to the HELOC is that you only have to pay interest on the amount you actually borrow, not on the entire amount you think you may actually need.

Home Equity Loan Pros

The biggest advantage to a home equity loan is that you have a large amount of money at your disposal when you really need it. If you have a great business opportunity that may soon evaporate, or you are short on your child’s college fund when he or she is ready to begin his or her undergraduate education, or you want to make improvements to increase the value of your house, having this extra money can be a great benefit. Another advantage is that you may be able to make that money work for you in a way that it cannot if it is just sitting in your house. In other words, if you can invest the equity in your home, the amount you earn may outweigh the amount you save in interest by paying down the mortgage. You may also find, if you are lucky, that the terms of the second mortgage are better than the terms of your first mortgage, so the simple act of refinancing may save you money (although the fees for the transaction must be considered).

Home Equity Loan Cons

The biggest disadvantage to a home equity loan is that you are putting your house on the line. As many mortgage holders learned over the past couple of years, this is not something to be taken lightly. If you are not able to make your mortgage payments, you can lose your house. In addition, some home equity loans can work on a scale where early payments are affordable but later ones are much higher. If you are not prepared for the higher payments you could have a real problem. You may also not be sure how much you need to borrow. If this is the case, to avoid taking on additional interest payments, you may wish to consider opting for a home equity line of credit instead.

TSC Sources and Recommended Resources

• What Home Equity Debt Is
• The Pros and Cons of Home Equity Loans and Lines of Credit
• Home Equity Loans Pros and Cons

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