6 Risks to Consider Before Tapping into Your Home Equity

With high interest rates and looming economic uncertainty, many homeowners are considering their home equity as a potential source of borrowing. After years of fast rising home valuesthe average homeowner with a mortgage now has approximately $300,000 of equity in your home, with around $190,000 potentially exploitable. At the same time, home equity loan rate remain relatively low compared to many other borrowing options.

Access your home equity 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, tuition fees or consolidating retirement savings. However, while tap into your home equity While this seems attractive right now, it also carries significant risks that should make any type of borrower think twice before proceeding.

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6 Risks to Consider Before Tapping into Your Home Equity

Here are some of the main risks to consider carefully before accessing money from your home equity:

Risk of seizure

The biggest risk of a home equity loan or HELOC is that you build your home. as a guarantee in return. If you don’t make payments on the money you borrow, the lender can seize your property.

If you borrow money with an unsecured loan, like a personal loanmissed payments will hurt your credit but it will not endanger your property. With home equity debt, this risk is at the forefront. And given that your home is likely your most valuable asset (or one of your most valuable assets), it’s not something to take lightly.

Risk of getting into too much debt

Another major risk of tapping into your home equity is that it makes it very easy for you to accumulate significant debt. When you use a home equity loan or HELOC for targeted needs, like 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 your lifestyle you can’t really afford it long term.

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Risk of diving underwater at home

Taking out a loan against the equity in your home also increases the risk that if real estate prices fall, you could find yourself underwater and owing more on your mortgage and home equity than your home is worth. This makes it impossible to terminate 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 equity

Every dollar you borrow against the equity in your home that’s a dollar you no longer have access to if you need it later. If property prices rise over time, you won’t be able to borrow against the increased equity – at least until your loan is fully paid off.

Risk of paying too much interest

While home equity loan rates are fixed, HELOC rates are generally variable, meaning they may change over time depending on the overall pricing environment. Although HELOCs often have relatively low introductory interest rates, if rates increase over time, this type of borrowing can end up becoming quite expensive.

There is also the risk that rising interest rates will make it more difficult to pay your mortgage and home equity debt. That said, you have the option of refinance your home equity loan or HELOC if rates drop over time.

Risk of missing out on tax deductions

In general, you cannot deduct interest on a home equity loan or HELOC if the funds were used for a specific purpose, such as repairing or significantly improving your home. If you don’t meet these criteria, the interest you pay on the money you borrow likely won’t be tax deductible.

Managing the risks associated with home equity loans

Although the risks of tapping into your home equity are significant, they can often be managed with caution if you are financially disciplined. For example, it is essential to have a realistic and concrete plan to repay any home equity debt within a reasonable time frame. And carefully managing the numbers is absolutely essential to ensure you can actually afford the payments, even if interest rates rise significantly.

You will also want to maintain a solid emergency fund with six to 12 months of separate spending of funds from 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 like temporarily reducing expenses, generating income through a side job, or investing in investments can also help guard against missed payments.

Taking a conservative view of potential house price appreciation in your area may also be wise before betting too much on a rapid increase in equity to offset your debt over time. It’s best to plan under the assumption that your home’s value will increase slightly, if at all, over the next five to 10 years.

Limit your combined mortgage and home equity debt to no more than 80% of your home’s value can also help provide protection if property prices fall. This prevents you from getting stuck in the water with your mortgage and not being able to move.

The essential

By being fully aware of the risks from the start and putting safeguards in place, accessing your home equity can potentially be a viable financial tool when used wisely. But borrowers should have a healthy appreciation for the dangers — including the possibility of losing their home to foreclosure — before moving forward.