As you buy your first home, there are several different types of loans or mortgages you can take out. A home equity loan is a specific type of loan where the borrower uses the equity, or value, of the house as collateral. In other words, you pledge your house value as security for a loan.
The world of financing and loans can be confusing, especially for the average person with no experience in that area. As such, there are many myths and misconceptions about home equity loans.
In this article, we’re going to clarify five myths and misconceptions about home equity loans, so you can move forward on your loan with the confidence and knowledge you need.
1. Home improvements
There is a common myth that home equity loans can only be used in or around the house, in the form of home improvements.
This is not true! Although home equity loans can be a good way to pay for a new bathroom or kitchen upgrade, they can also be used to fund your education, pay for a large event like a wedding, pay for plastic surgery or anything else your heart desires. With that said, plan your spending wisely because you will need to pay back your loan eventually!
2. Home equity loan vs home equity line of credit
The world of finance is a never-ending swirl of jargon and insider language that seems insignificant but actually makes a big difference in how money is handled.
An example of this is the difference between a home equity loan and a home equity line of credit. Although the words seem similar, they describe two distinct options. Both use your home as collateral, but the way the money is distributed is different.
Usually, a home equity loan is distributed in one large lump sum deposited directly to your account. The payments generally follow the traditional mortgage format of 5, 10 or 20 years.
By contrast, home equity lines of credit (HELOC) distributes the money on an as-needed basis. Interest rates and payment periods also differ between home equity loans and HELOCs.
3. Long-time owners only?
Another common misconception surrounding home equity loans is that there are minimum ownership duration requirements to take out a loan. This makes sense, because it is assumed that long-time owners have had more time to build up equity.
Luckily, your home equity is available to you as soon as you take ownership of the property. If you’ve made a sizable down payment, you’re all set.
4. Credit cards
A misconception, perhaps stemming from the name “home equity line of credit”, is that taking out a home equity loan automatically opens a credit card.
While in some states this is true, in others the money gets deposited directly into your account. Do your research on the rules in your home state.
5. Increases your risk of foreclosure
Using your home as collateral sounds worrying to many people. Whether you already have a mortgage or have paid it off, your home is an important asset and it seems foolish to risk it.
However, taking out a home equity loan does not actually increase your risk of foreclosure. In fact, the number of annual foreclosures related to home equity loans is so low that the percentage is usually rounded down to zero. Taking out a home equity loan is relatively risk-free.
Whether you are a first-time buyer or long-time home owner, a home equity loan has many advantages. Hopefully this article was helpful and cleared up the common myths and misconceptions surrounding home equity loans.