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with high interest rates and the looming economic uncertainty, many homeowners are looking at theirs home heritage as a potential source of debt. After years of fast the increase in home valuesthe average homeowner with a mortgage now has about $300,000 in home values, with about $190,000 potentially exploitable. At the same time, home loan rates they remain relatively low compared to many other loan options.
Access the value of your home with a home equity loan or a home equity line of credit (HELOC) can provide much-needed funds for things like home renovations, debt consolidation, college tuition bills or shoring up retirement savings. However, while taking advantage of the heritage of your home may seem attractive right now, it also carries significant risks that should give any type of borrower pause before proceeding.
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6 risks to consider before taking advantage of your home equity
Here are some key risks to consider carefully before accessing your home equity money:
Foreclosure risk
The biggest risk with a home equity loan or HELOC is that you are installing your home as a guarantee However. If you don't make payments on the money you owe, the lender can foreclose on your property.
If you borrow money with an unsecured loan, com a personal loanmissed payments will hurt your credit but it won't put your home ownership at risk. With home equity debt, this risk is at the fore. And since your home is probably your most valuable asset (or one of your most valuable assets), this is not something to be taken lightly.
Risk of getting into too much debt
Another major risk of tapping into your home equity is that it allows you to rack up a lot of debt very easily. When you use a home equity loan or HELOC for specific needs, such as paying for college or high interest debt consolidationmay make sense, it's easy to fall into the trap of treating it like a piggy bank to fund a lifestyle you really can't afford it long term.
Learn more about the best home equity loan rates you can get today.
Risk of diving into your home
Taking out a loan against your home equity also increases the risk that this if housing prices fall, you could end up underwater and owing more than your home is worth with your mortgage and home equity loans. This makes it impossible to get out of the mortgage without writing a big check to the lender and could make it difficult to sell your home or refinance your mortgage in the future.
Risk of reducing your home's equity
Every dollar you borrow against your home equity it's a dollar you no longer have access to if you need it later. If home prices rise over time, you'll lose the capital gains debt, at least until your loan is fully repaid.
Risk of paying too much interest
While home equity loan rates are fixed, HELOC rates they are usually variable, meaning they may change over time based on the general rate environment. Although HELOCs usually have relatively low initial interest rates, if the rates increase over time, this type of loan can end up getting quite expensive.
There's also the risk that rising interest rates could make it harder to make payments on your combined mortgage and home equity debt. That said, you have the option to do so refinance your home equity loan or HELOC if rates drop over time.
Risk of losing tax deductions
In general, you just can deduct the interest in a home equity loan or HELOC if the funds were used for a specific purpose, such as substantially repairing or improving your home. Don't forget this criterion and the interest you pay on the money you borrow will probably not be tax deductible.
Manage the risks of housing debt
While the risks of tapping into your home's equity are significant, they can often be be managed with prudence if you are financially disciplined. For example, it is critical to have a realistic and concrete plan to pay off any home equity debt within a reasonable amount of time. And, using the numbers carefully to make sure you can actually afford the payments, even if interest rates rise substantially, is an absolute must.
You'll also want to keep a solid emergency fund with expenses of six to 12 months independent of your home equity. This ensures that you have a reserve to continue making payments if you lose your job or face other financial difficulties. Having a backup plan, such as temporarily cutting expenses, generating income from a side gig, or dipping into investments, can also help protect against missed payments.
Taking a conservative view of potential home price appreciation in your local area may also be prudent before betting too much on quick capital appreciation to pay off your debt over time. It's best to plan on the assumption that your home's value will increase modestly, if at all, over the next five to ten years.
Limit your combined mortgage and home equity debt a no more than 80% of your home's value can also help provide a cushion if house prices fall. This protects you from diving into your mortgage and not being able to move.
The bottom line
By being fully aware of the risks upfront and putting in place guardrails, access to your home equity can be a viable financial tool when used judiciously. But borrowers should have a healthy respect for the dangers, including the potential loss of their home to foreclosure, before moving forward.
