Home equity loans give individuals a tool to extend their existing credit line by securing debt on the equity value of their existing homes. This access to easy and cheap money can lure the borrower into securing a debt for reasons which otherwise could have been funded through wise money management.
Following are some home equity loans risks:
Risk of losing one's home:
The biggest risk involved in home equity loans is that of the borrower being rendered homeless. In the case of the borrower being unable to make timely payments of the interest and the principal, the lender can claim the existing house of the borrower. Thus a default in payment can lead to the loss of the home, which is used as collateral for the loan.
Hidden loan conditions:
Consumers who do not pay careful heed to the fine print may fall prey to the intrinsic conditions of the home equity loan, particularly those pertaining to principal and interest payments. For example, a balloon payment of the principal may add to the debt burden of the borrower and the inability to make the payment may result in foreclosure and thus loss of the borrower's house. The lender may also impose legal and procedural fees later on in the term of the loan, which may affect the actual amount payable by the consumer.
Higher interest payments:
If the equity loan is financed at a floating or variable rate, then it is subject to changes depending on the interest rate scenario in the economy. This may be because the interest payments fluctuate out of the bounds of the borrower's reach.
Besides these major risks, the home on which the loan is secured cannot be leased during the term of the loan. The loan on home equity will also effectively increase the time required to pay off the debt on the existing home.
Many times, the easy availability of an equity loan can tempt a consumer to take the loan for day-to-day expenses, which actually add to his existing debt burden.
The investment made by the money raised through raising an equity loan should be financially more rewarding than the interest paid on the loan.
All these factors should hence be taken into consideration before taking a home equity loan.
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