Home Equity Loan Pitfalls And How To Avoid Them

Posted September 12 2017
by PenFed Your Money
Home Equity Loan Pitfalls And How To Avoid Them - PenFed Your Money Blog

If you've lived in your home for a few years and property values have remained the same or higher, your monthly mortgage payments have helped you build up equity. That means that when you need cash, tapping into your home’s equity can be a good way to get it. Both home equity loans and home equity lines of credit let you borrow from that equity at low interest rates, which makes them very appealing.

However, you have to be careful with home equity. Whether you get a loan or a line of credit, interest rates are low because the loan is secured by your home — meaning that if you don't pay your bills, your house is on the line.

But don't let that scare you off. Home equity can be a valuable resource as long as you use it wisely. Here are five home equity loan pitfalls and how you can avoid them.

Pitfall: Making an unrealistic payment plan

Because your home is collateral for these loans, it's important to have a payment plan that works for your finances. Before you start looking for a loan, it's important to look at your budget. What kind of monthly loan payment could you realistically afford?

Don't expect drastic budget cuts or financial windfalls to make loan payments easier — plan around what you can afford right now. Even if this means getting a smaller loan, It's for the best in the long run.

Pitfall: Getting stuck with unexpected costs

Just like any loan, a home equity loan or home equity line of credit comes with a lot of fine print — and you want to read every word of it. When you're shopping for a loan, be sure to find out all of the details. You'll want to know:

●      What's the interest rate? Is it adjustable or fixed?

●      What are my payments? Will they change over time? Is there a balloon payment at the end of the loan?

●      What are my closing costs?

●      Are there pre-payment penalties?  If you may pay your loan off early, this is especially important.

To be sure you can afford the loan you're signing on for, you'll want to know all of these details so you aren't saddled with unexpected — or unaffordable — costs later.

Pitfall: Not being able to manage interest rate adjustments

It can be tempting to get an adjustable rate loan (common for home equity lines of credit) because the initial interest rate is lower. However, this can create problems if you aren't prepared for interest rates to go up — and your payment to go up, with it.

This is back to being sure you can afford the loan you're getting. Be sure you know whether your payments may change and, if so, how often and by how much. When you're considering your budget, remember that your loan payments could go up — and you'll still have to pay them.

Pitfall: Getting the wrong kind of loan

While you may assume a home equity loan and a home equity line of credit are interchangeable, these two financial products work differently. A home equity loan is exactly what it sounds like: a loan that gives you a set amount of money that you pay back over time. Interest rates on these loans are typically fixed and payments are the same for the life of the loan. This is an ideal option for predictability, but you may not need (or want) a lump sum all at once.

A home equity line of credit is a bit more like a credit card — only one tied to the equity of your home. Your line of credit is good for up to a certain dollar amount, and you can borrow from it until you reach that dollar amount, then you pay back what you've borrowed. The payments on these are less predictable because they vary based on how much you've borrowed — plus the interest rate is typically adjustable, meaning your interest (and thus payment) can go up. This allows a lot more flexibility, but budgeting for changing can be trickier.

Depending on what you need the money for, a loan or line of credit may make more sense. Be sure you're getting the right type of loan for your situation.

Pitfall: Using your home equity as an easy out

If you're in financial trouble, borrowing against your home's equity can seem like a good solution. However, if you borrow to solve a problem but never address the issues that caused it, you're just going to get back into trouble — only now you're risking your house to do it.

For example, you might borrow against your equity in order to pay off high interest credit card bills with a low interest equity loan. This can be a good way to get out of debt and save money on interest — but if you continue the spending habits that got you into credit card debt in the first place, you'll soon find yourself back at square one. When you're borrowing against your home equity, you want to be sure you're practicing good financial habits.

Consider a home equity loan or line of credit from PenFed

We offer loans and lines of credit with low interest rates and payment plans to fit any budget. Our low APR home equity products allow for a low cost way to access your equity, whether you're looking to remodel or fund your dream vacation.