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Home Equity Loans - A Big Benefit Or A Big Mistake?
By Felicity Walker
When the bills are piling up and there doesn't seem to be any way out, a home equity loan can seem like the answer to your prayers. Home equity loans can also be a great way to jumpstart a business or investment portfolio. However it's important to realise that in some circumstances, a home equity loan may in fact make your life a whole lot worse.
A home equity loan is like a second mortgage on your home. If your home is currently worth $130,000, and you have a mortgage against it for $70,000, then you have $60,000 of equity available. Some home equity loans may allow you to borrow up to 80% of your home's value, others may go higher in special circumstances. In this example, you would be able to borrow another $34,000 as a home equity loan and still have only borrowed 80%.
Before making the decision to borrow more, though, it's important to sit down and really think about what you're doing. Firstly, and most importantly, why do you want the money? This is a really crucial part of your decision making. Many people use a home equity loan to fund necessary repairs to their home, or make improvements and so improve their home's value. In that situation, a home equity loan is a great idea, as the extra borrowings will most likely be offset by the increase in your home's value - as long as you can afford the extra repayments.
Borrowing to fund a business may also be a good use of home equity loan funds. It's important, though, not to put your money into a business without any track record, because you may well be throwing it away. Also, never use a home equity loan to try and resurrect a business that's losing money rapidly. You'll just end up with a bigger mortgage payment headache and nothing else. But if you have a business that is thriving and desperately needs some funds to expand, a home equity loan may well be the solution if banks aren't interested in giving you standard business finance.
Investing is another possible use of your home equity loan funds. Again, it's important to think carefully about what you plan to invest in. You could use the home equity loan as a deposit on an investment property. Or you could use it to be good quality shares. You may well regret it, though, if you buy the latest hot tip speculative share! Choose carefully and wisely, and a home equity loan can be a great way to start your investment portfolio.
Debt consolidation is another popular reason for taking out a home equity loan, and can be beneficial, but only if done wisely. There's no point increasing the debt on your home to clear your credit card debt, only to turn around and spend, spend, spend until all your cards are at their limits again. You need to close all of the cards as soon as they're paid off, or only keep one with a small limit for necessary purchases.
There are other reasons for a home equity loan which can make it a useful source of funds, but in these situations it's really important to be sure that you have no other options, and you can afford the repayments. These may include educational expenses, unexpected medical expenses or a family emergency.
There's also one reason that is very rarely a good reason to put your family home in further debt - big ticket items. Maybe it will feel really good to have that long vacation, or buy that expensive television and furniture, but ask yourself if it's really necessary or important. If spending the money on unnecessary things means that somewhere down the track you lose your home, you'll have paid for those things with a lot more than money.
If you think carefully about a home equity loan, and assess your reasons for borrowing more against the family home logically rather than emotionally, then you will be able to make a sensible choice. A final thought - always assess your ability to repay the loan based on reality and perhaps even "worst case scenario" values, rather than optimistic estimates of overtime at work or a promotion. That way you'll be able to make the payments and enjoy your family home for many more years to come.
Copyright Felicity Walker 2005
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