Seven Dangers of Home Equity Loans
Avoid these Home Equity Loan Dangers
If you’re in need of money and have equity built in your house, home equity loans may seem like logical solutions to your cash needs. Unfortunately, if you are not aware of the dangers and responsibilities with paying your loan, a home equity loan can leave you in a financial mess. Here are seven home equity loan dangers to watch out for:
1. Oops you did it again! Using a home equity loan to consolidate or refinance debt and then just adding on more debt.
If for example, you’ve gotten in over your head with credit card debt or high-interest loans and are overwhelmed with high rates and multiple payments, a home equity loan can seem like a good solution. If you’re disciplined, it can be. If not, well that can spell trouble. Refinancing your debt with a home equity loan will free up available credit from the credit cards or loans you pay down. If you act irresponsibly and charge up those credit cards again, you will quickly end up in a worse position than you started. Converting unsecured debt to secured debt may not always be the best answer. You need to be fully aware and mindful of the fact that your home is used as collateral for a home equity loan and if you fail to pay on your loan, you could end up losing your home.
2. Consolidating your debt may cost you more in the long run.
In addition to the pitfall mentioned above, if you are consolidating debt into a home equity loan or HELOC with the intention of paying less in interest, make sure that’s actually the case. If you extend the repayment terms significantly, the overall cost of your debt may actually increase due to this increased term. If you’re consolidating shorter-term debt to a 15- or 30-year term, interest can add up quickly. To see what we mean, test out some interest rates and terms on the Benchmark Federal Credit Union loan calculator. To be a good option, a home equity loan needs to make financial sense.
3. Borrowing against the equity in your home with the intention of completing a large remodel project to increase your home’s value.
Oftentimes we are under the mistaken impression that a large home improvement project will significantly increase the value of our home. That’s not always the case. You may be surprised to learn that the upscale kitchen remodel you have planned may not reap you the financial reward you might think. If you’re remodeling with the goal of increasing value or getting a 100 percent return on your investment, do your homework first to be sure the project you have planned is worth the investment. Take a glance at the 2019 Cost vs. Value Report, which compares average costs for 22 remodeling projects with the value those projects retain at resale in 136 U.S. markets. It’s a good starting point when planning a remodel.
4. Fluctuating monthly payments that can wreak havoc with your budget.
If you were lured by the low adjustable interest rate of a HELOC or an interest-only payment period, you may find yourself with monthly payments that change significantly as interest rates fluctuate or the interest-only payment period ends. A home equity loan may be a better option for budget planning. Forewarned is forearmed.
5. Failing to shop for the best home equity loan product to meet your needs.
Different lenders offer different deals. Some may lure you with an extremely low rate, others with no closing costs. Finding the best deal can potentially save you thousands of dollars. You need to compare everything equally when shopping for a home equity loan or HELOC. Start with your local credit union, as they always have the best interest of their members in mind. Factors to compare include interest rate, fixed or adjustable, how much you can borrow, repayment terms, all costs and fees (closing costs, application fees, etc.) and any other terms. Read the fine print and ask questions. Choose wisely before applying for a home equity loan or HELOC.
6. Spending beyond your means just because the money is available.
So, you borrowed a HELOC with a specific purpose in mind, such as tuition costs or home repairs, only to have used a large portion of it to buy an expensive toy you really didn’t need. Or, you used it as your own personal ATM. Either way, the temptation of that available money was just too great for you to handle. Now the tuition bill is due, and the money is gone. When borrowing against the equity in your home, you should only do so when it’s for items that will improve your financial situation or your quality of life. This can include home improvements, educational costs, emergency expenses or a major life event, such as a wedding. Using the equity in your home as “mad money” is never a good thing.
7. You don’t fully understand the risks.
As we mentioned in #1 above, failure to pay on your home equity loan can result in your losing your home. If you can’t make your payments, the lender could foreclose. You may think you have a secure job and then the unexpected happens and you lose it. With it goes your ability to pay on your loan. Another important item for consideration is the possibility of a drop in home values. If the value of your home declines you could potentially end up underwater, which means you will owe more than your house is actually worth. Talk to your lender about the potential risks.
We hope the above dangers provide you with some food for thought when considering tapping into the equity of your home. Done correctly and with all of the potential problems in mind, a home equity loan can provide you with the funds you need for many things, from home improvements to paying those unexpected medical expenses. Learn more about Benchmark Federal Credit Union home equity loans or HELOCs.