The Right Way to Use a Home-Equity Loan

The Right Way to Use a Home-Equity Loan

Home-equity loans can be valuable tools for responsible borrowers. If you have a steady, reliable source of income and know that you will be able to repay the loan, its low interest rate and tax deductibility of paid interest makes it a sensible alternative. Fixed-rate home-equity loans can help cover the cost of a single, large purchase, such a new roof on your home or an unexpected medical bill. And the HELOC providers a convenient way to cover short-term, recurring costs, such as the quarterly tuition's for a four-year degree at a  college.
Recognizing Pitfalls
The main pitfall associated with home-equity loans is that they sometimes seem to be an easy solution for a borrower who may have fallen into a perpetual cycle of spending, borrowing, spending and sinking deeper into debts. Unfortunately, this scenario is so common the lenders have a term for it: reloading, which is basically the habit of taking a loan in order to pay off existing debt and free up additional credit, which the borrower then uses to make additional purchasing.

Reloading leads to a spiraling cycle of debt that often convinces borrowers to turn to home-equity loans offering an amount worth 125% of the equity in the borrower's house. This type of loan often comes with higher fees because, as the borrower has taken out more money than the house is worth, the loan is not secured by collateral. Furthermore, the interest paid on the portion of the loan that is above the value of the home is not tax deductible.