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It is important to understand the truth about home equity loans so that you don't run into future problems. Lenders may not tell you the entire story when you seek to borrow on the equity of your home. Before you consider taking this step, consider the following information about home equity loans.
The Lure of Consolidation
Having multiple credit card and loan payments can seem like a lot to keep track of. Many times consolidating these bills is an attractive option, because only one monthly payment is required. There are two problems with using home equity for the consolidation of other debts: interest rates and spending habits.
Over time, depending on the interest rate, you may end up spending a lot more on interest than you would have by paying separate bills. For example, if you have a $1,000 balance on your credit card with an interest rate of 14 percent, you can pay it off in four months for a few hundred dollars. When combined with other debts in an equity loan at a nine percent rate, that same $1,000 will actually cost you a few thousand more dollars in five years. Even though the interest rate is lower, the extended low payments will cost a lot more in the long run.
There is also the temptation to continue poor spending habits once the bills are consolidated. Nothing is really paid off, the debt is just moved. If you don't improve your spending habits, you could end up accumulating a far worse amount of debt than before.
Home Equity for Repairs
It is better to save up the money to make cosmetic upgrades and repairs on your home. Unless there is an emergency situation, borrowing on equity for home improvement projects can cost a great deal of money beyond the expense of the project due to interest over time. The pitfall that may occur is that you might borrow more than your home is currently worth and the future market declines. You may not be able to recover the money in a sale. What is worse is that if you fail to make the payments, you could lose your home entirely.
Foolish Reasons to Borrow
Home equity is not meant for everyday spending money. Borrowing on the equity of your home for holiday shopping, a new car, food, clothing, or otherwise relying on this debt for everyday living is a financial disaster waiting to happen.
Consolidating bills that do not charge interest with a home equity loan is also a poor financial decision. If it does not cost you to make the separate payments, don't borrow against your home. You would only seemingly reduce the amount you pay on a monthly basis, but over time, you are spending a great deal more because of the interest.
The bottom line is that home equity loans are risky. There is no guarantee that the value of your home will increase by the time you wish to sell. You also risk extreme financial hardships should your household income suddenly be cut. The biggest risk is losing your home all together.
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