Home Equity Loans: Borrower Beware!

Slick advertising materials urge consumers to renovate their homes, buy second homes or fund college education for their children with home equity. But before jumping to purchase a home equity loan, carefully consider your situation as well as the risks associated with home equity loans. 

Sometimes, a home equity loan can make sense. If you have high interest debts, a home equity loan can help you consolidate debts into one low interest payment. Also, interest on home equity loans is tax deductible, while credit card and other consumer debt is not. Just about every lender will point out these favorable features to convince you to borrow against your home’s value. However-

It is important to consider the “flip side” before signing the loan documents:

  • Home equity loans are another mortgage on your home. If you can’t make the payments, you will lose your home.
  • If you sell your home later, and it has declined in value, you will be responsible for a large loan payment, with only current earnings to make payments. It’s hard to recover from this kind of financial hit.
  • For many of us, our home is our largest retirement asset. Equity in a home can be used in a “reverse mortgage” in retirement years to access funds for living expenses. Proceeds from the sale of a home can be used to buy a place in an assisted living facility or to buy a smaller home. If you’ve spent your equity, you will not have this nest egg.
  • If you borrow to make home improvements, be sure that they will increase your home’s value. Otherwise, you’ve wasted the money. A qualified realtor can advise you about this. Many homeowners are surprised to find out that their home improvements did not translate to a higher sales price.
  • If you borrow to pay off high interest debt, and then run those debts back up again, you will find yourself in a bigger financial hole. Carefully examine the reasons why you are in debt, and make a plan to stay out of debt before taking a home equity loan. If you don’t, you will only be increasing your overall debt level, not improving it.

The next time you see an advertisement for a dream vacation or fancy home improvement project, just close your eyes and picture the retirement of your dreams instead.

For additional information about home equity loans, check out WISER’s fact sheet: Home Equity Loans.

 

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