Home Equity Loan: Advantages and Disadvantages

You can use a home equity loan for almost anything  – buying a new house, a trip with your family, urgent medical costs, or even home renovations, which could contribute towards improving the property’s value, and therefore its equity.

With a home equity loan, a lender may not investigate why you’re choosing to opt for it as compared to the strict eligibility requirements attached to some other types of loans. However, different lenders may have different processes in place, but, in general, there are fewer restrictions attached to how you can use a home equity loan than some other financing options, such as personal loans or car loans. 

It’s also helpful that you can access the equity in your home in a few different ways through a home equity loan. These include:

1. Line of credit

The line of credit option acts like a credit card with a pre-approved credit limit. You can borrow funds against your home as long as it doesn’t cross the credit limit during a particular period which is called the drawdown period. Any amounts borrowed then are subject to interest-only repayments. After the drawdown period, you will have to pay the principal and interest amount due on the home equity loan. 

With the home equity loan line of credit option, you will only have to make interest payments during the drawdown period. This could help you save money or pay off other expensive loans in the short term.

2. Lump sum

The lump sum option lets you use the equity as security to borrow money. This lump sum has to be repaid with interest.

3. Reverse mortgage

Reverse Mortgage is an option available for retirees who own property. It is typically used to assist them with their retirement costs. A part of the value of the property is accessible as steady income or as a lump sum amount. It gets repaid when the property is sold or if the borrowers move into an aged care home or pass on.

Once you opt for a home equity loan, it reduces the usable equity in your home, and your repayment amounts may increase because you’ve withdrawn from the amount of money paid towards the loan, thus increasing the balance you owe on the home.

There is no set repayment term for a home equity loan, and it can be added to the mortgage balance and be subject to repayments over your loan term as compared to a three-year fixed personal loan. The additional interest, and higher loan balance on the home with an increased loan repayment period make home equity loans less attractive.

If you cannot repay the loan for any reason, your credit score would be affected, and the lender could eventually repossess your property.

Before you sign up for a home equity loan, it is best to check with a mortgage broker and to consider comparing other options like refinancing, a personal loan or even a credit card. You might find it helpful to learn about the differences between a home equity loan and a personal loan to select the right financing option for you.