Advantages And Disadvantages Of Home Equity Loans

Author: John Tahan

For example, nearly 50 percent of credit line holders cited the convenience of obtaining money as needed as an important advantage; only 7 percent of traditional home equity loan users mentioned this factor (table 6). In addition, in comparing users of the two types of loans, a larger proportion of the credit line holders mentioned cost, principally a lack of fees, as an important advantage. Many observers have suggested that tax deductibility of interest payments likely is an important factor contributing to the recent growth of home equity credit lines, and the survey responses support this conclusion. Nearly 30 percent of credit line holders and 16 percent of traditional home equity loan users mentioned tax deductibility as an advantage of home equity loans compared with other types of consumer credit. Consumers also cited several potential disadvantages of home equity products. Roughly equal proportions of the users of each type of home equity product mentioned the risk of losing the home as a disadvantage, but credit line holders expressed concerns about possible debt  overextension

extension beyond the normal limit for a joint, commonly causing sprain of its ligaments. twice as frequently as users of traditional home equity loans. Likewise, a higher proportion of credit line users cited cost (interest rate) as a disadvantage of this type of credit, probably reflecting simultaneously the sensitivity to prices of this upscale group of borrowers and the variable rates on most of these accounts.9

In sum, survey evidence suggests that holders of credit lines and users of closed-end loans represent different market segments, albeit with some similarities and overlaps. Credit line holders have somewhat higher incomes and more equity in their homes, but, so far at least, have borrowed less. Debt repayment and home improvement are the main uses of both kinds of loan, but the credit lines are also used more broadly for other purposes. Credit line holders are more likely to mention convenience as an advantage, but they also more often mention the cost in terms of variable interest rates and the risk of possible debt overextension as disadvantages.

Significantly, lack of knowledge about alternatives does not appear to be associated with the selection of loan type. The 1988 surveys show 9. Virtually all credit line accounts have a variable interest rate feature, typically one that allows monthly adjustments that are indexed to changes in the prime rate or to some other short-term money market rate.

Table : 1. Sources of home equity loans

Table : 2. Characteristics of homeowners, by debt status

Table : 3. Proportion of homeowners with home equity loans, by demographic characteristic

Table : 4. Outstanding balance on home equity loans

Table : 5. Purpose of home equity borrowing, by type of loan

Table : 6. Advantages and disadvantages cited by holders of home equity loans, by loan type that 92 percent of all homeowners are aware of that availability of traditional home equity loans, and 75 percent are aware of home equity lines of credit. In comparing the two types of credit, about 90 percent of users of each type were aware of the availability of the other product. But, despite their high levels of awareness, most users of either a traditional home equity loan or of a credit line account did not seriously consider the other type of credit instrument before obtaining their current loan. Among homeowners with a traditional home equity loan, only 16 percent considered obtaining a line of credit instead. Similarly, among homeowners with a credit line, only 20 percent considered taking out a traditional home equity loan. This lack of cross-product shopping likely reflects factors such as the differences in loan purpose discussed earlier. For instance, as previously noted, many credit line holders seem to have established their accounts as standby lines with no immediate use intended, and roughly three-quarters of them mentioned convenience (in one form or another) as a key advantage of that loan product.
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