Is Home Equity Loan a Good Idea?

By Remitbee - Jun 22, 2022

What is a home equity loan?

Home equity is the appraised value of your home. In other words, it tells you how much of your home you own. A home equity loan can be used as collateral for a loan by homeowners. Essentially, you're borrowing against the value of your home.

Home equity loans can be used for various purposes, such as making home improvements, consolidating debt, or paying for major expenses such as college tuition or medical bills.

A second mortgage is another term for it. The key difference between a home equity loan and a traditional mortgage is that you will get a single lump-sum payment from your lender with a home equity loan. You repay your loan at a set interest rate as soon as you receive it. That means you'll pay a fixed monthly amount for the duration of the loan.

Is it worth it?

Home equity loans in Canada allow you to borrow up to 80% of the property's market value, minus the balance of your primary mortgage. You may estimate your home's worth by using home valuation tools, looking at similar houses previously sold in your neighbourhood, or hiring a professional home appraiser.

Once you get a rough estimate, calculate 80% of those numbers. Then deduct the remaining amount on your mortgage to determine how much equity you have.

Canada has more than 250 top lending firms. It's a good idea to get a home equity loan if you plan to use the cash to enhance your home or consolidate debt at a cheaper interest rate.

If you're confident in your ability to make timely payments, borrowing against your home equity may be worthwhile - mainly if the loan is used for home improvements or other projects that will help boost your home equity. However, if you get behind on payments, you may face some problems.

What are the pros and cons of a Home Equity Loan?

Pros

Home equity loans are an easy way to get money and can be helpful for responsible debtors. Low-interest rates and possibly tax deductions make home equity loans a good alternative if you have a stable, reliable source of income and know you'll be able to repay the loan.

Many homeowners find getting a home equity loan easier because it is a secured obligation. The lender does a credit check and seeks an appraisal of your home to determine your creditworthiness and the combined loan-to-value ratio.

Even higher than a first mortgage, the interest rate on a home equity loan is significantly lower than that on credit cards and other consumer loans.

One of the most common reasons customers take out a fixed-rate home equity loan is to pay off credit card debt.

If you know how much you need to borrow and for what purpose, a home equity loan is one of the best options. You're guaranteed a particular sum, which you'll get in full at the end of the transaction.

Cons

For many homeowners, a home equity loan can seem like an attractive solution to their financial problems. After all, what could be easier than borrowing against the equity in your home? However, home equity loans can often be problematic for borrowers caught in a never-ending cycle of spending and borrowing.

Unfortunately, this situation is so typical that borrowers take out loans to pay off existing debt and free up new credit but then use it to make additional purchases. Lenders even have a term for this: reloading.

Reloading creates a debt spiral that drives many borrowers to seek home equity loans, which provide up to 125% of the loaner's property equity. Once the borrower has taken out more money than the house is worth, the loan is not fully secured by collateral and therefore gets higher fees.

Also, keep in mind that interest paid on the part of the loan that exceeds the home's worth is never deductible.

Because you only get the payoff once and don't know if you'll be eligible for another loan in the future, it's tempting to borrow more than you need when applying for a home equity loan.

How to avoid risks when getting a Home Equity Loan?

A home equity loan is worth considering if you've been thinking about ways to turn your home equity into cash. Not only will you be able to get your hands on some much-needed cash, but you can also use the money to make improvements to your home that will boost its value.

However, keep in mind that you're putting your home on the line, and if real estate values fall, you could wind up paying more than your home is worth.

Also, if you decide to relocate, you may lose money on selling your house or be unable to do so. Moreover, if you're taking out a loan to pay off credit card debt, resist the urge to run up new credit card debt. Consider all of your choices before doing something that puts your home in trouble.

When considering a large home equity loan, compare rates on several loan options. Depending on how much money you need, a cash-out refinance may be a better choice than a home equity loan.

Working with a reliable financial or lending advisor during the application process is a good idea. Speaking with a specialist and obtaining sound advice ensures that the procedure for you and your family goes as smoothly as possible. This also allows you to assess your financial requirements and possibilities and prepare for the home equity loan application procedure.

The first step is meeting with a loan counsellor. This can be daunting, but there's no need to worry - just come prepared with all your questions. And if you're not sure what to ask, a little research beforehand can go a long way.

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