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Jordan Goodman is the author of Everyone's Money Book, available at 888-201-6300. This is the third edition of the book. You can also visit his Web site at www.moneyanswers.com. He talks with us on Thursday mornings.
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February 20, 2003
"Pros and Cons of Home Equity Loans"
 Listen
Americans will borrow against any asset they’ve got, whether it is their
401(k), insurance policy, or even pawning their wedding ring. But the hottest asset
to tap today is your own home through a home equity line of credit. Because
home values have risen so sharply -- economists estimate a $500 billion rise in
2002 alone -- homes are an inviting place to borrow money to pay off credit
cards, car loans, student loans and all kinds of other debts.
But there are some definite trade-offs in taking out a home equity loan. Here are some of them:
Advantages:
- Very low interest rates: The average rate on variable home equity loans is
about 4% today, and about 7% on fixed rate loans. Some banks even offer
teaser rates of 1% to 2% for the first six months or a year. That is far lower
than credit cards, student loans or almost any other type of debt.
- Deductible interest: As long as the loan is secured by real estate, you
can deduct interest of up to $100,000 in home equity loan debt on top of
your primary mortgage.
- Flexibility: You can tap the home equity line whenever you want with a
check and pay it off as quickly or slowly as you want.
Disadvantages:
- You lose your home if you don’t repay the loan: You are putting your house
on the line, and many people who lose income can’t make the payments and end
up in foreclosure.
- Fees and closing costs can be onerous: Many home equity lenders are adding
fees -- like annual fees, credit checks, recording fees, appraisal fees and
other closing costs -- to these loans. These can really add up, particularly if
you don’t have a great credit record. If you shop around, you might be able
to negotiate away some or all of these fees.
- These loans can tempt you to spend more than you should: Many homeowners
open a home equity credit line, use it to pay off credit card and other
debts, and then spend on the credit cards all over again since they are
freed up. People who take out a 125% home equity loan now owe 25% more than
their house is worth, which makes it almost impossible to sell their house
or move.
- You might be converting short-term debt into long-term debt: It is not a
good idea to pay off a dinner you charged on your credit card a month ago
into a 10- or 15-year loan in a home equity loan. You will end up paying far
more in interest than the dinner cost.
- Interest rates can go up: The vast majority of home equity loans offer
variable rates, and that's great as long as rates have fallen; if
rates rise, you could end up paying a lot more interest.
Home equity loans can be a great way to save money and tap the equity you
have built up in your home, but you don’t want to get too carried away,
jeopardizing your house and ending up paying far more interest than you
should over many years.
For More Financial Tips From Jordan Goodman
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