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A home equity loan, or second mortgage, allows you to withdraw the equity you’ve built up in your home so you can use the cash to make repairs to your home, pay for college tuition, or consolidate your debt, for example.

You repay the money over time through a series of regular payments. Home equity loans have a number of benefits, but there are some downsides to consider as well. If you’re not sure if a home equity loan is right for you, you can weigh the pros and cons of alternatives such as lines of credit, refinancing, or personal loans.

Downsides of Using a Home Equity Loan

While many homeowners appreciate the flexibility home equity loans offer, there are some drawbacks to this type of financing. Among the downsides is the fact that your home secures these loans. So if you can no longer afford to make the payments—for example, if you lose your job—you could lose your house.

In addition, this type of loan adds a payment to your budget each month. If your cash flow is tight and you’re using the money for expenses other than consolidating your bills, a second mortgage might not be a good fit.

Having a home equity may also limit your ability to refinance your primary mortgage. So if you want to refinance for better terms on your original mortgage, you may want to delay taking on a home equity loan. Consult your lender or a financial advisor for guidance on your specific situation.

If you’re not sure if a home equity loan is right for you, consider the pros and cons of the following alternatives.

Home Equity Line of Credit (HELOC)

A home equity line of credit, or HELOC, is another type of second mortgage. It’s similar to a home equity loan because you’re accessing the equity built up in your home. But unlike with a regular loan, a HELOC works more like a credit card with a revolving line of credit.

You’re approved for a certain amount of money. You then can access those funds anytime you need them during the loan’s draw period. During this time, you only pay interest on the money you’ve used.

HELOCs usually have variable interest rates. So among the downsides of these loans, your payments won’t be the same each month, which means you won’t have predictable monthly payments.

Once the draw period is over, you’ll need to start repaying the principal, which means your payments will be larger. In some cases, a lender may require a balloon payment, or payment in full, although most HELOCs provide repayment periods of about 10 to 20 years.

If you can’t afford the higher payment, your bank may allow you to refinance your HELOC.

Cash Out Refinance

A cash-out refinance is another option for tapping equity in your home. This type of loan is when you take out a new primary mortgage for more than the amount you currently owe. As with a home equity loan, you get this extra money in a lump sum of cash, and you can spend the funds any way you’d like.

With a cash-out refinance, you won’t add a second payment each month. You can get a cash-out refinance that doesn’t add to the amount of your monthly payments. However, you’ll extend the length of the loan. Also, since a cash-out refinance is a primary mortgage, you’ll usually qualify for better interest rates.

Furthermore, lenders may not require as high a credit score to approve you for a cash-out refinance compared to a home equity loan. So if you don’t have great credit, this could be a good alternative.

Keep in mind that whenever you refinance, you have to pay closing costs. If you don’t have a lot of money up front, taking out a home equity loan might make more sense.

Reverse Mortgage

If you’re at least 62, you may be eligible for a reverse mortgage. This type of loan lets you use your home equity to supplement your income in retirement.

You’re not required to make any payments with a reverse mortgage as long as you live in the home. These terms can save you money right now. The loan is due when the last borrower dies or moves out of the house. At that point, you or your heirs can sell the home to pay off the loan. If the sale price isn’t enough, you or your estate is responsible for making up the difference.

Reverse mortgages do have some drawbacks, such as high fees. You may need to pay for origination costs, mortgage insurance, and closing costs. Due to these limitations, a reverse mortgage may not make financial sense for everyone. Consider consulting a financial advisor about options for your situation.

Personal Loans

A personal loan is another home equity loan alternative. With this type of loan, you can borrow money and use it for any purpose. Unlike a home equity loan, you don’t have to use your home as collateral.

There are two main types of personal loans: secured and unsecured.

Secured Personal Loans

A secured personal loan uses your assets as collateral. If you can’t repay the loan, the lender can take the money from your account to cover the cost. Because there’s less risk for the lender, you may be able to get a lower interest rate.

You can use many different assets as collateral, including your home, but you can use other assets besides your home to back a secured personal loan. You can use, for example, a savings account, a stock portfolio, or even your vehicle.

Unsecured Personal Loans

An unsecured personal loan doesn’t require collateral. However, that means there’s more risk for the lender since they could lose money if you can’t repay the loan. As a result, it’s difficult to qualify for these loans.

You may need good or excellent credit to get approved for an unsecured personal loan. And even with excellent credit, you’re likely to still pay a higher interest rate compared to a secured loan or a home equity loan.

Credit Cards

Credit cards can be other alternatives to home equity loans. However, use them carefully because they generally have higher interest rates.

You could finance a project with your credit card and pay it off over time. Some credit cards offer a 0% APR promotional period in which you won’t accrue interest on your purchases until the promotional period expires. If you can pay it down before the 0% APR period ends, you essentially get a free loan. However, after that period, interest is applied to your remaining balance.

Read the fine print carefully because some carry a penalty APR as well as other potential fees or penalties.

Other Asset-Backed Loans

Other collateral loans may be a good fit for your financial situation. Here are three types to consider.

401(k) Loans

If you have a retirement 401(k) account, which is an employer-sponsored account, you may be able to borrow money from it. With this type of loan, you can borrow up to $50,000 or half of your account balance, which is always less. However, the loan typically must be repaid within five years.

One significant downside of a 401(k) loan is that you’re borrowing from future retirement funds.

Car Title Loan

A car title loan can provide cash in an emergency. However, these short-term loans, which often last for only 30 days, have very high interest rates.

You’ll give the title to your vehicle to the lender until the loan is repaid. If you can’t pay back your loan on time, you’ll pay a large fee and could potentially lose your car.

CD Loan

You can use just about any personal property as collateral for a loan, including the value in a certificate of deposit (CD). In a financial emergency, this type of loan allows you to access the money in your CD without paying an early withdrawal penalty. Check with your bank regarding other potential fees.

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US gas prices reached a new record high Tuesday, erasing the modest relief seen in April.

Higher oil prices and increasing demand for gas pushed the average national price to $4.37 a gallon, according to data from AAA. As the chart below shows, the average has now surpassed the previous high of $4.33—fallout from Russia’s invasion of Ukraine.

The price of crude oil, which accounts for more than half the price at the gas pump, reached almost $110 a barrel last week after falling below $100 in late April. (As of Tuesday, it was back down around $100.) Those increases as well as rising demand and lower supplies of gas have been pressing pump prices higher, AAA said.

The national average for gas was $3.54 a gallon when Russia invaded Ukraine on Feb. 24. Sanctions against Russia proceeded to take as much as 3 million barrels of Russian oil off the market per day, increasing international oil demand and pushing prices higher. After the White House released oil saved in strategic reserves in late March, prices began to drop, but the downward trajectory was short-lived.

Have a question, comment, or story to share? You can reach Terry at tlane@thebalance.com.

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Definition and Examples of Bad Credit

Having bad credit means that negative factors appear in your credit history, indicating that you’re a risky borrower. Several factors can contribute to bad credit, including previous delinquencies, high debt balances, and recent bankruptcies.

Bad credit is usually indicated by a low credit score, the numerical summary of the information in your credit report. FICO scores are one of the most widely used credit scores. They range from 300 to 850, with higher scores being more desirable.

The FICO credit score range is broken up into five ratings:

• Exceptional: 800 and above
• Very Good: 740-799
• Good: 670-739
• Fair: 580-669
• Poor: Below 580

How Bad Credit Works

Your credit score is based on five factors. Each is weighted differently. All of them can contribute to bad credit.

• Payment history (35%): You’re likely to have a lower credit score if you have a history of delinquent debts and late payments, or credit cards that you haven’t paid off.
• Amounts owed (30%): A bad credit score is often due to owing large amounts of money. The more you already owe, the less likely it is that you’ll be able to pay off new debt.
• Length of credit history (15%): You’re a less risky borrower if you’ve been reliably paying off debts for many years. A shorter credit history will lead to a lower credit score. This is also influenced by how long your individual credit accounts have been open.
• Credit mix (10%): Having a variety of types of credit, such as a credit card, a retail card, a mortgage, a personal loan, and/or a car loan, improves your credit score. Having only one type of credit account will lower it.
• New credit (10%): People who open multiple new credit accounts in a short period of time are statistically riskier borrowers. They’re more likely to have bad credit.

Your credit score gives you and lenders a quick indication of your credit standing, but you don’t necessarily have to check your credit score to know if you probably have bad credit.

A few signs of damaged credit can include having your application for a loan, credit card, or apartment denied, or experiencing unexpected cuts to your credit limits. Your interest rates on existing accounts might rise, and you might receive communications from one or more debt collectors.

Your credit score has likely taken a hit if you’ve been more than 30 days late on a credit card or loan payment, or if you have multiple maxed-out credit cards.

Ordering your credit score from myFICO.com is one of the best ways to confirm your current credit standing. There are also a number of free credit score services you can use to check at least one of your scores from the most widely used credit bureaus: Equifax, Experian, and TransUnion.

You can take a look at your credit report to understand exactly what’s affecting your credit score. This document contains all of the information used to create your credit score.

What Are the Penalties for Bad Credit?

Having bad credit can make it difficult to get approved for new credit cards, a mortgage, or other loans. You may be offered a high interest rate or other unfavorable terms if you are approved.

Bad credit can impact other areas of your life, as well. Landlords may not accept you as a tenant, or they may only agree if you have a cosigner. Bad credit can even make it harder for you to get a job if your potential employer checks your credit score as part of your job application.

A good credit score shows that you’re a dependable borrower, which makes lenders more willing to have a relationship with you and give you funds. Consumers with very good or exceptional credit scores have better odds of loan, rental, and mortgage approvals. They can choose from a wider selection of credit card and loan products with more favorable interest rates.

How to Get Rid of Bad Credit

Having bad credit isn’t a permanent condition. You can improve your credit score and demonstrate that you’re a responsible borrower by correcting negative information and improving each of the five categories that make up your credit score.

Check and Correct Your Credit Report

Start by reviewing your credit report thoroughly. Look for any information that’s incorrect, such as paid debts that are listed as delinquent or accounts that you never opened. You can dispute these errors directly with the credit reporting company by sending a letter detailing any mistakes.

Check for information that should have been removed. With the exception of bankruptcy, negative information can only be listed on your credit report for up to seven years. You can dispute any negative items that haven’t expired.

Improve Your Credit Score

Removing negative information is just one part of the process. You should also add positive information by improving as many areas of your credit score as you can.

Keep your oldest credit account open and in good standing to add to your credit age. The longer you’ve had credit, the better it is for your credit score.

Don’t take on new debt or close credit cards in order to change your credit mix or amount of new credit. Closing credit accounts will suddenly leave you with a higher debt-to-available-credit ratio. It can negatively impact your credit score.

Focus on improving your payment history and lowering the amounts you owe. These are the two biggest factors in a bad credit score. Work toward bringing past-due bills current and paying down high balances. Continue to make regular payments on all your debts while focusing on paying off your larger ones.

Open new accounts sparingly. Take on only as much debt as you can afford. Make on-time payments. Keep your credit card balances low, and monitor your progress using a free credit score tool.

You might notice some improvement in your credit score right away when you’re caught up on payments, and positive information starts to show up on your credit report. It can take anywhere from several months to a few years to completely fix your bad credit, depending on how low your credit score was to start with.

Definition and Examples of Loan/Lease Payoff Insurance

Standard loan/lease payoff insurance pays the amount you owe on a totaled vehicle’s loan after your insurance company has paid you because your car has been totaled in an accident or it’s been stolen. You can only purchase this type of insurance if you’re buying the most comprehensive coverage insurance on your vehicle. It typically pays up to 25% of the vehicle’s current cash value (ACV), allowing for any insurance deductible.

• Alternate name: Gap insurance

For instance, if you bought your car and still owe $20,000 on it, it may only have a Kelly Blue Book value of $15,000. You are “upside down” on your car loan. If you are then in an accident where your car is totaled, your insurance may only pay you for the value of the car, which is $15,000. That means you still owe $5,000 to the bank for the remaining balance on your car loan. Payoff or gap insurance could help you pay the bank some or all of that remaining balance.

How Loan/Lease Payoff Insurance Works

The term “loan/lease payoff” is often used in place of gap insurance. Both coverages work in a similar way, but there are some subtle differences between the two. Providers can assign their own sets of rules to loan/lease payoff insurance that separate one type of insurance from the other. Other providers might not distinguish between the two coverages at all.

Suppose that John has purchased a new Chevy truck for $28,000. He purchased the truck with a 0% down payment and an extended six-year loan to keep his payments low.

Unfortunately, the truck is stolen within a month of purchase. The insurance company determines that the ACV of John’s truck is just $21,000 due to the plunging value of these vehicles when they’re driven off the lot. That’s a difference of $7,000, compared to what John Owens on the loan.

Luckily, John purchased loan/lease payoff coverage through his car insurance provider. This insurance will cover 25% of his ACV. It works out like this:

• 25% of $21,000 is $5,250.
• The insurance company will therefore pay $26,150 after subtracting a $100 deductible.
• John is responsible for paying for the remaining $1,850 balance.

John must pay out of pocket to meet his obligation, but he’s still better off than he would have been without the loan/lease payoff coverage, even though his loan wasn’t paid off in full. This is an extreme example of depreciation and no down payment, and it’s an unlikely scenario.

Loan/Lease Insurance vs. Gap Insurance

Gap insurance tends to be a bit more generous and flexible than loan/lease payoff coverage and in some critical ways. You can often avoid out-of-pocket costs at all with gap insurance. You won’t be forced to come up with a portion of the balance in order to retire the loan against the destroyed or stolen vehicle.

Loan/Lease Payoff Insurance	Gap Insurance
Does not cover deductibles	May cover deductibles
Pays only up to 25% of the vehicle’s current cash value	Pays the difference between the vehicle’s current cash value and the loan balance against it

Do I Need to Buy This Coverage?

It’s always best to discuss this type of coverage with your insurance agent rather than deciding on your own whether you need it. Make sure you understand all the details and restrictions that apply to loan/lease payoff agreements.

It can provide helpful coverage even if it doesn’t pay 100% of what you owe, and it will certainly come in handy compared to not having any access to coverage when you know you’re underwater on your car loan. However, some consumer advocates argue that the premiums for these coverages are often too high given that claim payouts are fairly infrequent.

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