The Pros and Cons of Home Equity Loans

Obtaining a home equity loan is a common method of refinancing debt and it has several advantages. But there are a few potential 'gotchas' that are worth considering before taking the plunge.When you take out a home equity loan you obtain a line of credit, secured by the equity in your home. So, if you have a certain amount of ownership in your house, as a result of having made a down payment or payments over a few years, you can borrow against that equity.

Many homeowners will take out a HELOC (Home Equity Line of Credit), as they're called, in order to use the money for many purposes such as financing home improvements. That purpose gave the loan its original name. But, because of tax implications and other reasons, the HELOC evolved to serve other purposes.

Interest paid on most kinds of debt is not tax deductible, but interest paid on a home loan is. Hence, interest paid on a HELOC can actually be a form of less expensive debt.

Suppose, you have a 12% HELOC for up to $10,000. With most HELOCs you don't actually borrow the entire amount at once. You draw on it, much as you would a credit card, as needed and desired.

This has multiple benefits. You could borrow only what you need - keeping the payments and the interest owed as low as possible. And, you get to reduce your taxes by a percentage of the interest paid per year.

The big thing to remember is that, like any loan, a home equity loan is just that - a loan, or debt.  It isn't free money.

So, if for any reason you find your self unable to pay back the loan unforeseen circumstance, or if one of your major problems is the inability to exert the will to refrain from spending beyond your means,  a home equity loan may actually make your more fundamental problem worse, rather than better.