What to Consider before Taking Out Home Equity Lines of Credit

Home equity lines of credit allow you to put the equity you have built in your residence to good use. The main goal of home ownership, when compared to renting, is to provide for financial stability and an asset base in the future. Never using the asset makes little financial sense. However, overusing the asset through too much financing is also detrimental. Consider the expense of the loan as well as its purpose before deciding if your current home equity line of credit option is viable.

Home Equity Line of Credit Expense

The main factor in the expense of your home equity line will be the interest rate. Most equity lines are dispensed as revolving credit, meaning you will get to choose when to spend the money and how much to pay back monthly. This is a very flexible financing option. However, it can also be a very expensive option. Revolving lines are often variable rate loans. Further, interest compounds more frequently on most revolving lines than on installment debt. If you are not disciplined enough to pay down your balance each month, you may find the cost is very high.

Home Equity Line of Credit Purpose

The purpose of your home equity line of credit should also be a primary factor in whether or not you take the loan option. Home equity lines are best used when they contribute a valuable asset to your financial profile. Since you are pulling equity out of your home in order to make the purchase, the goal should be to put equity back in with any purchase you make. Examples include business lines of credit, rehabilitation lines of credit for the property or using the line of credit to purchase another property. Spending the money on a non-equity purchase may be irresponsible.

Home Equity Line of Credit Drawbacks

Aside from expense, the biggest drawback of a home equity line of credit is the risk it poses to your current home loan. Above all else, you should avoid over mortgaging your property. This can lead to too much debt; too much debt typically leads to default or bankruptcy. Always maintaining at least a 4:1 equity to debt ratio will help you steer clear of bankruptcy. When you collateralize some of your equity, you are throwing off that balance. Defaulting on your home equity line can lead to a foreclosure if your secondary lender buys your first mortgage and forecloses on your property.

Other Financing Options to Consider

You may consider taking out a personal loan that is not based on the equity you have in your home for your expense. If you are planning on spending the money on a luxury purchase, like a vacation, then this option may be best. Personal loans have higher interest rates than loans secured with your home's value. However, they have much lower risk for you. Even if you default on a personal loan, the lender will have no claim to the deed to your residence, and your primary asset will remain in good standing.

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