Pros and Cons of a Home Equity Loan: What You Should Know

The pros and cons of a home equity loan are essential to understand if you’re interested in doing home improvement projects or major home renovations. The right knowledge about this potential loan option can help you make the ideal decision for your situation. Let’s review some of the pros and cons of a home equity loan.

8 Pros of a Home Equity Loan

There are many benefits of obtaining a home equity loan if you’re interested in using the funding to do home improvement projects. Some of the benefits include:

1. Lower Interest Rates: The lower interest rates are a major perk of getting a home equity loan, especially compared to what you would pay if you decide to put your home improvement projects on a credit card. Additionally, whatever your interest rate is when you obtain the home equity loan will remain as-is throughout its duration. 
2. Using Your Equity in Your Favor: Another benefit of a home equity loan is that you use the existing equity in your favor to make the home improvement projects you want to do. This, in turn, may help raise the overall value of your property, depending on the projects you complete.
3. Ability to Complete the Desired Projects: If you qualify for a home equity loan, one of the biggest benefits is that you can use it to do the larger projects you’ve wanted to do, ranging from replacing your roof to swapping out your current HVAC system for something more energy efficient. Doing certain home improvement projects has its own potential benefits, including lowering your monthly utility bills and feeling more content with the condition of your space. 
4. You Don’t Need a Perfect Credit Score: Many homeowners love that you don’t need a perfect credit score to be able to qualify for a home equity loan. The typical acceptable base is approximately 620, but the higher your credit score is, the better. 
5. Tax Deductibility: Interest paid on a home equity loan might be tax deductible if the funds are used for qualifying home improvements. Consult with your tax professional for more specifics. 
6. Credit Building: When you successfully manage and repay a home equity loan, you positively impact your credit score.
7. Flexible Loan Terms: Many lenders offer various loan terms, allowing you to choose what best suits your current financial situation.
8. Quick Access to Cash: The application process is usually quick, which allows faster access to the funds you need. 

8 Cons of a Home Equity Loan

As important as it is to know about the pros of getting a home equity loan, it’s also vital to understand the potential downsides. A few of the cons of a home equity loan are:

1. Putting Your Home at Risk: If you can’t make your payments, you put your home at risk for foreclosure. A home equity loan uses the equity in your home and is considered a second mortgage. It’s important to make sure that you’re agreeing to monthly payments that you’re confident you’ll be able to make. 
2. You Need a Healthy Financial Standing: A credit score of approximately 620 isn’t all you’ll need to qualify for a home equity loan. There are many other factors to consider, including your current income, how much equity you have in your home, and your debt-to-income ratio. All of this information and then some will be taken into consideration. 
3. Increased Debt Burden: Many homeowners might not realize how much stress may be involved in taking out a home equity loan, especially if it’s a large amount. This means you’re required to pay all your standard bills and expenses plus your initial mortgage payment and your monthly payment for the home equity loan. It’s one of the many reasons it’s vital to evaluate if you can afford to take on the added expense. 
4. You Could Put Added Stress on Personal Relationships: If you’re involving additional people in the home equity loan process, you’re not only taking the stress of the payment on yourself, but you’re also putting it on another person. For example, if you and your spouse are both on the loan or you request the help of a friend to be a consignor, they’re also along for the ride with you. 
5. Limited Flexibility: A home equity loan provides you with a large lump sum rather than giving you flexible access to funds.
6. You Can Potentially Overspend: Having access to a larger amount of money may encourage you to spend too much on renovations. 
7. Longer Repayment Terms: When you choose a home equity loan, you are agreeing to a commitment to a long repayment period that can potentially affect your future financial decisions.
8. Impact on Your Credit Score: When you take on additional debt, it can negatively affect your credit utilization ratio.

Fees Often Associated With Home Equity Loans

When you go with a home equity loan, you will find that most lenders do charge fees. 

• Closing Costs: Fees involved with processing the loan, including underwriting, title searches, and document preparation.
• Appraisal Fees: The home is appraised to determine its current market value. This typically ranges between $300 and $500.
• Title Insurance: This insurance protects the lender against any issues that might arise with the title.
• Origination Fees: The lender charges this fee when they process the loan application. It can be a flat fee or a percentage of the loan amount, usually no more than 0.5% to 1%. 
• Prepayment Penalties: Some lenders may charge a prepayment penalty if you pay the loan early. This is why you need to read and understand the loan terms before signing.
• Escrow Fees: Sometimes, a lender requires an escrow account for property taxes or insurance. Setting this up may incur fees. 

Home Equity Loan vs Mortgage Refinancing

Once you learn the pros and cons, it’s time to weigh your options. Some may wonder how a home equity loan stacks up against a mortgage refinance, for example. 

When you refinance your mortgage, you can pay off your original mortgage with a new loan, potentially lower your payments and change loan terms, and consolidate debt by taking cash out. However, your existing interest rate on the mortgage may change, which can be disadvantageous for many homeowners. 

However, the closing costs may be much higher, your loan term may be extended, and the lender may require additional paperwork with a longer approval process. Choosing between these options comes down to your financial goals and what you need the funding for. 

Consider all of your long-term financial plans. A home equity loan will be the more suitable option if you need the funds for a specific purpose, while refinancing is best if you simply want to lower your monthly payments or change your mortgage terms. 

Your Home’s Value Following Renovation Projects

Unfortunately, there’s no guarantee that any home improvement project will increase your home’s value. Several factors are involved, including the project you want to do. However, certain large-scale home improvement projects could increase your chances of boosting your home’s value, some of which include:

• Replacing your roof
• Changing your HVAC system
• Adding a deck
• Finishing your basement
• Making the attic into a livable space
• Renovating your kitchen

Weighing the Pros and Cons of a Home Equity Loan vs RenoFi 

The best thing you can do is research. It’s not a decision you want to make lightly. Using our pre-qualification tool is a great option for getting started with determining what your options are. You should also take advantage of our Home Equity Loans resources section.

Let’s go through a couple simple examples to demonstrate how you can borrow more money using RenoFi vs. a traditional home equity loan. 

In this example, we are going to assume we want to borrow $150,000 to renovate our home and those renovations would increase the value by $150,000.

Scenario 1 (New Home Purchase):

• Home price: $600,000
• Downpayment (20%): $120,000
• Current Mortgage Amount: $480,000

Example Home Equity Loan Amount: 

• $600,000 * 80% = $480,000 (80% of Total Home Value)
• $480,000 - $480,000 (Current Mortgage Balance) = $0 (Home Equity Loan Amount)

Example RenoFi Home Equity Loan Amount:

• Assuming that your renovation project will add $150,000 to your home value

• After Renovation Value of Your Home: $750,000

• RenoFi Loan Amount: 

  • $750,000 * 90% = $675,000 (90% of Total Home Value)
  • $675,000 - $480,000 = $195,000 (RenoFi Home Equity Loan Amount)

Using a RenoFi Home Equity Loan you have increased your loan amount from $0 to $195,000. Not only are you now able to borrow the $150,000 you wanted to renovate your home, but you can now borrow up to $195,000 because the RenoFi loan is written against your ARV (After Renovation Value).

Without RenoFi loans, you would not have been able to borrow the $150,000 needed to add the renovations that would increase the value of your home by $150,000. Now, with RenoFi loans, you are now able to get the loan you need to add the renovations you want to your home.

Scenario 2 (Recent Home Purchase): Assuming that you have now paid 10% of your mortgage:

• Home price: $600,000
• Current Mortgage Amount: $420,000

Example Home Equity Loan Amount: 

• Example Home Equity Loan % of Home Price: 80%

• Example Home Equity Loan Amount: 

  • $600,000 * 80% = $480,000 (80% of Total Home Value)
  • $480,000 - $420,000 (Current Mortgage Balance) = $60,000 (Home Equity Loan Amount)

Example RenoFi Home Equity Loan Amount:

• Assuming that your renovation project will add $150,000 to your home value

• After Renovation Value of Your Home: $750,000

• RenoFi Loan Amount: 

  • $750,000 * 90% = $675,000 (90% of Total Home Value)
  • $675,000 - $420,000 = $255,000 (RenoFi Home Equity Loan Amount)

Using a RenoFi Home Equity Loan you have increased your loan amount from $60,000 to $255,000 (4.25x more). Not only are you now able to borrow the $150,000 you wanted to renovate your home, but you can now borrow up to $255,000 because the RenoFi loan is written against your ARV (After Renovation Value). 

Here’s a summary of the difference between traditional and RenoFi home loans in table form: 

In addition to letting you borrow more money for your home renovations, RenoFi loans also offer:

• No draw periods
• No inspections
• No need to give up your original loan
• Higher borrowing limits

RenoFi loans are funded on the day the loan is closed and that is it. Take out the $195k and you get $195k in your bank and you have 20 years to pay off in equal monthly payments with interest and principal, just like a standard mortgage.

Conclusion

Don’t wait to learn more about qualifying for a home equity loan, which could be the answer you need to finally do the home renovation projects on your wish list. RenoFi loans are the smartest way to finance a home renovation project. 

Unlike traditional loans, which are based on your current home value or require you to refinance your primary mortgage and give up your low rate, RenoFi loans are based on the after-renovation value of your home. This allows you to borrow, on average, 11x more, get a low monthly payment, and keep your low rate on your first mortgage. 

Contact RenoFi today for information about how we can help you obtain a home equity loan from top-notch credit unions. 

Explore your RenoFi loan options here.