There are some misleading assumptions about Home Equity Loans floating around out there. Let’s dismiss those notions and explain why they’re wrong.
Misconception #1: You Can Only Use a Home Equity Loan to Pay for Home Improvements
Not so! You certainly can use the money to upgrade your kitchen or put in a new bathroom, but you can also use it to fund a college education, buy a second property, pay for cosmetic surgery, put in a pool, or finance a large celebration like a wedding – among other things. Just because “home” is in the name and your home is the collateral doesn’t mean it has to be used for your home.
Misconception #2: There is No Difference between a Home Equity Loan and a Home Equity Line of Credit
While both use the equity in your home as collateral, they are distributed in different ways. A Home Equity Loan provides the borrower with a one-time, lump-sum disbursement. Home Equity Loans also follow the format of a traditional mortgage in that payments begin immediately for a period of 5, 10, 15 or 20 years.
A HELOC parcels out the money on an as-needed basis at the request of the borrower. HELOC’s do not have a fixed rate, so whatever you are being charged is subject to periodic changes throughout the life of the loan. HELOC’s also have a draw period of 10 years during which a borrower need only pay down on the interest. The principal must be reduced to zero in the second 10 years.
Misconception #3: Home Equity Loans Cannot Be Paid Off with Minimum Monthly Payments
HELs are not paid off like credit cards – there is no minimum monthly payment that allows you to keep putting off the inevitable. They are paid off like mortgages, with a set payment every month allowing you to pay off the loan within the allotted time frame.
Misconception #4: Home Equity Loans Come with a Credit Card
In some other states they do, but not in Texas. Instead, the money is deposited directly into your account.
Misconception #5: Foreclosures on Home Equity Loans are Common
Not so. While a borrower can lose their home for failing to make payments on their home equity loan, it is a very rare occurrence in Texas. It’s so rare, in fact, the percentage is usually rounded down to zero.
Misconception #6: Simply Getting a Home Equity Loan Can Damage Your Credit Score
Not at all. What will damage your rating, however, is not making timely payments on your Home Equity Loan. If you’re punctual, it will actually help your credit score.
Misconception #7: A Home Equity Loan is a Good Way to Provide Overdraft Protection for a Checking Account
Having a Home Equity Loan in place does not provide automatic overdraft protection for the checking account you might have with the lending institution. You will have to make separate arrangements to make sure your overdrafts are covered properly.
Misconception #8: Home Equity Loans Are Not Available to Those Who Have Just Purchased Their Homes
The equity in your home is available to you to use as collateral immediately upon taking possession of the property. Naturally, it is assumed that longer-term residents have built up more equity, but there are no minimum ownership duration requirements attached to getting a Home Equity Loan. So, if you made a sizable down payment, you can immediately begin drawing upon the equity it provides.
Misconception #9: A Home Equity Loan is a Great Way to Finance an Auto or Truck Purchase
This is a bad idea for several reasons. First of all, depending on your credit score, you could get a much lower rate on a car loan – especially if a dealer is running a special on a model they are trying to move off the lot. Second, Home Equity Loans have much longer payment periods than car loans do. You don’t want to be paying for your car 10 years from now! And finally, vehicles mostly lose value while homes mostly gain it. You don’t want to finance a depreciating commodity with an appreciating one. On the other hand, a Home Equity Loan is a great to finance the purchase of a recreational vehicle.