How Beneficial Is A Home Equity Loan?

Before I answer the question, let me try and explain what a home equity loan exactly is.

A home equity loan is basically a loan based on the equity in your home. It's simply an amount of money you can borrow as a homeowner against the equity in your home.

Most people consider the equity in their homes as a safety net and something they can fall back on rainy days, when a family illness or a job loss or an urgent personal expenditure occurs without forewarning. A good policy for debt management is to focus on your home's equity.
It's always best never to let your debts exceed the equity at any time.

Coming back to the question, how beneficial is a home equity loan?

I would say that it all depends on how well you can manage your money. If you are a prudent spender and spend the proceeds from the loan on items that are really very important and carry a higher interest rate, your home equity loan can prove extremely beneficial.

For instance, home improvements or college tuition fees are generally quite expensive and the pay-off periods are quite long. By using your equity, you will be able to write-off your purchase interest on your federal and state taxes.

You could also payoff high interest credit card bills and personal loan debts. But you must ensure that once the debt has been repaid you should not accumulate any more credit card debts.

Home-equity loans are often the easiest source for cash. The interest rate on a home-equity loan, though much higher than that of a first mortgage, is considerably lower than on credit cards and other loans.

One of the most common reasons that people borrow against the equity of their homes as against a fixed rate home equity loan, is to pay off outstanding credit card balances. The interest paid on a home-equity loan is also tax deductible. So, by consolidating debts with the home equity loans, as a borrower you will get a single payment, a lower interest rate and will also be able to avail of the tax benefits.

Home equity loans are quite beneficial for the lenders too. The lenders after earning interest and fees on the borrower's initial mortgage, earn even more interest and fees. In case of a borrower defaulting, the lender will keep all the money earned on the initial mortgage and all the money earned on the home equity loan. The lender also gets to repossess the property, sell it again and restart the cycle with the next borrower.

Home equity loans can be beneficial tools if you are responsible and prudent as a borrower. If you have a steady and reliable income and are quite sure that you will be able to repay the loan amount within its tenure, its low interest rate and tax deductibility of paid interest make it a practical option. Fixed rate home equity loans can help cover the cost of a single, large purchase, like an unexpected medical bill or sudden home improvement.

The greatest drawback of a home equity loan is that it sometimes seems to be a gravy train for a borrower who has the bad habit of spending, borrowing, spending and going deeper into debt. The habit of taking a loan to repay an existing debt and free up additional credit, which the borrower then uses to make additional purchases, has been termed as 'reloading' and can be quite a dangerous phenomenon.

Reloading creates an unending cycle of debt that often misleads borrowers to turn to home-equity loans offering an amount worth 125% of the equity in the borrower's house. This type of loan often comes with much higher interest rates since the borrower's credit worthiness is low and since he has borrowed more money than the house is really worth. Apart from this, the interest paid on the portion of the loan that is over and above the value of the home is not tax deductible.

If you're serious considering borrowing against the equity in your home, its best to be conscious of the fact that you are attaching a new lien on your home and heading nearer to the risk of foreclosure. If you do not make your payments on time, the lender is entitled to foreclose on your home. It's also best that you don't accumulate more debt than you can handle. Always remember that your total debt should NEVER exceed your homes total equity. It would be considered quite wise to avoid lines of credit unless you have the discipline to make the principal payment on time and to evaluate the tax benefits minutely.

How you plan on using the equity in your home is also an important consideration. If you need the money for home improvements, then you are enhancing and appreciating your home's value. If you need it to go on a holiday or to buy a new car or for any other reasons that will cause more depreciation that appreciation, you could be risking your equity and inviting the risk of owing money far beyond the average 15-30 year mortgage.

In a nutshell, a home equity loan can be quite a beneficial source of finance, as long as you consciously and cautiously decide to make it work for you.