A home equity loan can be an easy and relatively inexpensive way to access cash, but you will still pay a price. Borrowing against your home’s equity risks your home and prevents you from building wealth over the long term. Just like with a home equity line of credit (HELOC), taking out a home equity loan for anything that won’t directly increase your home’s value is usually not recommended. These are the top things for which you should never use your home equity loan.
Key Takeaways
- A home equity loan risks your home and erodes your net worth.
- Don’t take out a home equity loan to consolidate debt without addressing the behavior that created the debt.
- Don’t use home equity to fund a lifestyle your income doesn’t support.
- Don’t take out a home equity loan to pay for college or buy a car.
- Don’t take out a home equity loan to invest.
Paying Off Debt Without a Plan in Place
Home equity loans have much cheaper interest rates than other forms of unsecured debt such as credit cards because they use the equity you have in your home as collateral. It can be very tempting to consolidate a large balance of high-interest debt into a lower-interest-rate home equity loan.
Second Mortgage
"Remember that with a home equity loan, you are putting a second mortgage on your home. You should only do that when you either have no choice or it makes good financial sense."
—Kimberly Foss, founder and president, Empyrion Wealth Management
Taking out more debt to pay off existing debt can make good financial sense, but only if you have a good plan in place.If you don’t address the spending habits that got you into debt in the first place or don’t actually use your home equity loan to pay off your debt, you’ll find yourself in a much worse situation overall. If unpaid, credit card debt can tank your credit—but an unpaid home equity loan will lead to foreclosure and possibly losing your home. Don’t risk it if you don’t have the discipline or ability to pay it off.
Funding a Lavish Lifestyle
Using a home equity loan to finance a lifestyle your regular income can’t sustain is very unwise. Going on a dream vacation, eating at nice restaurants with your friends, or keeping up appearances among a successful social circle all sound nice, but you’re risking your home by using home equity to buy them. If taking out a home equity loan is the only way to finance your dream wedding, you need to reassess your dream and go with something more modest, increase your income, or delay until you have the cash saved to do it.
Paying for College
Taking out a home equity loan to pay for college risks your own home to pay for a degree that may not ever be finished or utilized. If you have college-aged children, you are most likely within your last few working years before retirement. In that case, taking on a large debt like a home equity loan can delay your own retirement. Look into other college funding options before taking out a home equity loan.
Buying a Car
You should never take out a home equity loan to buy a car. Auto loan interest rates are rising higher than home equity loan rates, and an auto loan doesn’t erode your home’s equity or risk foreclosure if you can’t pay it back.
Using a home equity loan to invest should be avoided. “Home equity should never be accessed for speculative purposes, including the purchase of real estate, because if the market goes against you, you could lose the value you’ve built up in your home,” says Kimberly Foss, founder and president of Empyrion Wealth Management.
Though some expert real estate investors and stock market speculators have risen to fame over the past several years making millions by leveraging their home’s equity, they are the exception, not the rule. Don’t risk your own home for an investment that could go to zero and leave you without a roof over your head.
What Are Alternatives to a Home Equity Loan?
The best alternatives to a home equity loan depend on the amount needed, the purpose, and how quickly you need the cash. Budgeting and saving for a known expense is your best option. If you don’t have that ability, an auto loan, 0% APR credit card, personal loan, or student loan are all options that still carry risks but don’t use your home as collateral.
What Is the Best Use of a Home Equity Loan?
“For persons planning a major remodel or renovation, and for certain people who are retired or near retirement, accessing a larger amount of home equity via a true home equity loan can be a good strategy,” Foss says, but adds a note of caution. "You have to look carefully at all your other available resources, your income, the interest rate environment, and other factors before you commit to a home equity loan.”
Is It Easier to Be Approved for a Home Equity Loan or a HELOC?
Both a HELOC and a home equity loan have the same equity requirements, credit score, and debt-to-income requirements. There is no evidence suggesting which type has easier approval requirements.
The Bottom Line
A home equity loan allows you to borrow a lump sum of money against your home’s value to use on whatever you want.Don’t risk your home and waste the hard-earned equity you’ve built in it for anything other than something that will increase your home’s value.
FAQs
Using home equity loans for purposes like monthly expenses, buying a car, paying for a vacation, or investing in real estate is generally not advisable. Instead, these loans should be used for home improvements or consolidating debt with a lower interest rate.
What should you not use a home equity loan for? ›
Don't: Use it to Pay for Vacations, Basic Expenses, or Luxury Items. You have worked hard to create the equity you have in your home. Avoid using it on anything that doesn't help improve your financial position in the long run.
What is one disadvantage of using a home equity loan? ›
Home Equity Loan Disadvantages
Higher Interest Rate Than a HELOC: Home equity loans tend to have a higher interest rate than home equity lines of credit, so you may pay more interest over the life of the loan. Your Home Will Be Used As Collateral: Failure to make on-time monthly payments will hurt your credit score.
Which of the following would not be a good use of a home equity loan? ›
Final answer: Buying a new boat would not be a good use of a home equity loan.
Can you spend a home equity loan on anything? ›
Yes, you can use the proceeds of a home equity loan or HELOC for anything you want. Whether you should is another matter. In general, tapping home equity is better for major home renovations or other goals that will further your financial life, such as paying off debt.
Should I pay off credit card debt with a home equity loan? ›
Using a home equity loan to pay off credit card debt can be a smart move, but it's not without risk. Since credit card debt usually has a much higher interest rate than mortgage debt, you could save money and get out of debt faster with this strategy.
Is it smart to use home equity to pay off debt? ›
Using a HELOC for debt consolidation can open up the doors to lower interest rates and streamlined payments. But it also carries risks. With a HELOC, your home is used as collateral, and you could lose it to foreclosure if you fail to make your payments.
What is the catch to a home equity loan? ›
If you default on the payments, you could lose possession of your home through foreclosure. You'll pay closing costs. As with most loans involving real estate, you'll most likely have to pay home equity loan closing costs. These costs can range from 2% to 5% of the loan amount.
What are the dangers of equity financing? ›
With equity financing, you risk giving up ownership and control of your business. Cost: Both debt and equity financing can be expensive. With debt financing, you will have to pay interest on the loan. With equity financing, you will have to give up a portion of your ownership stake in the company.
Is pulling equity out of your house a good idea? ›
Key Takeaways
A home equity loan allows you to borrow a lump sum of money against your home's equity and pay it back over time with fixed monthly payments. A home equity loan is a good idea when used to increase your home's value. A home equity loan is a bad idea when used to spend frivolously.
Choosing the right home equity financing depends entirely on your unique situation. Typically, HELOCs will have lower interest rates and greater payment flexibility, but if you need all the money at once, a home equity loan is better. If you are trying to decide, think about the purpose of the financing.
Is home equity risky? ›
Risk of Losing Your Home
For that reason, defaulting on your loan or missing payments could cause you to lose your home to foreclosure. This is probably the biggest downside to taking out a home equity loan, so making sure you can make the payments before signing the loan documents is essential.
What is the risk of using the equity in your home as collateral? ›
Like home equity loans, you use your home as collateral for a HELOC. This can put your home at risk if you can't make your payments or they're late. And, if you sell your home, most HELOCs make you pay off your credit line at the same time.
What is the cheapest way to get equity out of your house? ›
A home equity line of credit, or HELOC, is typically the most inexpensive way to tap into your home's equity.
Can I pull equity out of my house without refinancing? ›
Yes, you can take equity out of your home without refinancing your current mortgage by using a home equity loan or a home equity line of credit (HELOC). Both options allow you to borrow against the equity in your home, but they work a bit differently.
What bank has the best home equity loan? ›
While you may not qualify for a loan with all of these lenders, you can use our list as a starting point to compare offers and options.
- Navy Federal: Our top pick.
- U.S. Bank: Best for large loans.
- TD Bank: Best for rate transparency.
- Third Federal: Best interest rates.
- Spring EQ: Best for maximum equity.
Cons. You'll need to repay a large amount: Equity sharing agreements often have repayment terms ranging from 10 to 30 years — at the end of which, the whole debt comes due.
Are there restrictions on what you can use a HELOC for? ›
Like a home equity loan, a HELOC can be used for anything you want.
What does a home equity loan have to be used for? ›
If you qualify for a home equity loan, you can use it for your life's significant expenses such as home renovation, emergency medical bills, or to pay off debt.
