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Borrowers weigh a number of options when thinking about taking out a loan. Well, they should think about certain things. Procuring the wrong lending option can lead to a lot of troubles. Making a bad decision when borrowing could lead to paying more than what is necessary. Bad loans almost always come with ridiculous interest rates and terms.

Home equity lines of credit are sought by many since these forms of credit are relatively inexpensive and painless to acquire. Truth be told, home equity lines of credit come with many positives. Are either perfect? “Perfect” is a nebulous term. No source of credit is perfect, although lending institutions may hint at absolute perfection in the marketing campaigns. Home equity lines of credit do present some drawbacks.

Borrowers need to properly understand all the pros and cons associated with a home equity line of credit. Through such understanding, the best and most informed borrowing decision can be made.

The Structure of Home Equity Borrowing

The first thing to understand a home equity line of credit is what such a loan actually is.

A home equity line of credit is revolving credit borrowed off the value of a house. A bank or other financial institution will assess a borrowing amount based on the sale value of the property. If the home is worth $150,000, a bank could provide a home equity line of, say, $60,000. Lenders usually will go as high as issuing a line of credit that is upwards of 85% of the value of the home.

If there is still a mortgage owed on the home, the amount of money afforded via a home equity loan will diminish. If a property is worth $200,000 and $100,000 is owed, the line of credit ends up being issued based on removing the amount still owed from on a mortgage from the equation.

Once approved for a line of credit, the borrower/homeowner could then access the line of credit in a manner no different from a personal line of credit. The debt would not be fixed in the way a personal loan is issued. Monthly payments are required, but fixed payments over a set period of time are not mandated. Borrowing again and again on the remaining available credit is possible.

In a way, lines of credit are similar to credit cards. Since this type of line of credit is secured by the owned property, the limits can be quite high.

The Major Advantages

There are a few major advantages to acquiring a home equity line of credit. One benefit is the credit lines are much more easily approved than unsecured loans. The value of the house backs the borrowing. As such, a lender is better able to approve an application to a borrower.

Interest rates on home equity lines of credit are usually quite low. Lower interest rates are common with home equity lines since these are secured loans. When collateral is present, the lender is taking less of a risk than would be the case with a personal line of credit on a checking account.

The interest rates on a home equity line of credit remain fixed. Variable interest rates can be costly. Many borrowers find themselves in a lot of trouble when variable interest rates increase. Mortgages with variable lines of credit that increase are sometimes at the root of a foreclosure situation.

Personal lines of credit are usually capped at low amounts. $10,000 to $15,000 would be the ceiling for most people hoping to be approved for an unsecured loan. Home equity loans, as already noted, come with much higher ceilings based on the available equity in the home.

Drawbacks to a Home Equity Line of Credit

The main drawback to a home equity line of credit is also its main advantage. While borrowing from home equity is fairly easy, the home is the collateral on a default. Anyone who defaults on the money borrowed from a line of credit may find him or herself in foreclosure. Entering into foreclosure could end up being disastrous for most people, but default would make such a situation unavoidable.

Another problem may arise. Imagine borrowing a tremendous amount of money on a line of credit only to see the real estate market collapse in a few short years. Now, the home is not worth what it once was but the amount of the debt remains the same.

Plan Carefully

Taking out a home equity line of credit may seem too good to turn down. Borrowers do need to think things through before ever borrowing money on a home. Borrowers must select solid lenders capable of offering good terms and highly reasonable interest rates.

Most importantly, borrowers should only utilize home equity lines of credit for the right reasons and should never compromise their financial health.