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Can a Home Equity Loan Work Against You?

Taking out a home equity loan is one of the best ways to finance your remodeling project in Provo, Lindon, Mapleton, Santaquin, or anywhere else in Utah County.

It is a second mortgage, for applying for it means borrowing against your property. It allows you to tap up to 85% of the equity built on your house over time. If you have been paying down your mortgage halfway, you might be able to access enough funds to convert your attic, renovate your bathroom, or give your kitchen a complete makeover.

But just like any forms of financing, there is a time to take advantage of this option. It can backfire on you do not think it through. Below are the common scenarios where a home equity loan might cause you more harm than good.

When You Need a High Credit Score for Something Soon

Getting a home equity loan can be a massive blow to your credit. It increases your level of debt, adds a new account under your name, and triggers a hard inquiry. The combination of these three activities can remove numerous points from your FICO scores. You can recover over time, but it will get worse before it gets better.

Even if you are not planning to take another debt soon, you might need your credit for other things. Creditors are not the only ones that look at FICO scores. Insurance companies and employers are also interested in them.

If you are planning to switch insurance providers or apply to a different job, you might need to be in your best credit standing to get a favorable result.

When You Do Not Budget for Your Project Properly

Exterior renovation of a modern house and construction equipments

As a general rule, you should set aside at least one-fifth of your overall budget to cover contingencies. Otherwise, a change order can stall the construction and cause you a lot of headaches due to lack of funds.

You do not want to touch your emergency savings just because you run out of money in the middle of your project. Since your credit is no longer as good after your home equity loan approval, you might have to settle with a high-interest debt to access more cash instantly.

Take your time to understand the financial side of your budget. Allow no allowances in the estimate, and commit to the original plan to avoid dealing with additional costs later on.

When Property Values Drop

The most significant danger of taking out a home equity loan is watching your mortgage go under when the local real estate market tanks. When property prices drop, you can end up owing more on your house than what it is worth.

Negative equity on your property is not a concern if you do not want to sell, and if you continue to pay your financial obligations. It becomes a problem only when you are desperate to get rid of it to beat a foreclosure.

Every home improvement financing option carries risk, and a home equity loan is no exception. Understand how it works to avoid pitfalls and determine whether it is the best source of instant cash in your situation.

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