Avoid Pitfalls When Getting Home Equity Loans

Are you wondering how to avoid the pitfalls of a home equity loan? You’ve come to the right place for answers. Every month, more than 6,900 people visit this website seeking advice on loans.

In this easy-to-read guide, we’ll address the following questions:

• What is home equity?
• What is the downside of a home equity loan?
• How to avoid the pitfalls of a home equity loan?
• What are the risks of a home equity loan?
• Can you lose your house with a home equity loan?
• Is it bad to take equity out of your house?

We know that understanding home equity loans can be a bit tricky. But don’t worry; we’re here to help you make an informed decision.

Home equity defined

Equity is the amount of an asset you own without any debt, therefore, home equity is the amount of your home you own outright. To calculate your home equity you must subtract the value of your existing mortgage from the current value of your home – not the price you paid for it. If you have any other debts secured against your property or home equity then these also need to be subtracted. 

For example, if you have a home worth £250,000 and a remaining mortgage balance of £150,000 then your home equity will be £100,000. Equity is usually expressed as a percentage of an asset. In this example, the homeowner would have 40% equity in their property. 

What is the downside of a home equity loan?

Losing your home is a real possibility if you take out a home equity loan irresponsibly. But the other downside of using these loans is the closing costs. A closing cost is a fee payable at the end of the loan term. You could be asked to pay between 2% and 5% of your total amount of borrowing. 

For example, a loan of just £10,000 could cop you an additional £200 to £500 fee. Closing costs can wipe out any savings you would make through a lower interest rate. You need to know the extent of these fees when agreeing; they could make unsecured credit options more attractive. 

How to avoid the pitfalls of a home equity loan

You cannot avoid all of the risks associated with taking out an equity loan over the long run, but you can mitigate some of those risks. 

The biggest pitfall to avoid is overborrowing and not being able to make repayments should your income level change. Unforeseen events can cause your income to drop, such as ill-health or injury, which you may not be considering. This could lead to defaults and even foreclosure. 

By not borrowing more than what is needed you can mitigate this problem. You should also keep a monthly budget to monitor spending while repaying. 

If you are worried that your property could become less valuable, then do not utilise all of the equity available. This is good guidance even if you are confident your property value will increase.

Another way to mitigate the risks of home equity loans is to avoid this method if you are using it to solve cash flow problems. Taking out more credit in difficult circumstances is extremely dangerous and it could easily backfire. 

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Home equity loan risks summarised

The pitfalls of getting a home equity loan can be summarised as:

1. Home at risk – this will only occur if you cannot pay back what is owed.
2. Unforeseen cost – you may sign the credit agreement without fully understanding additional fees.
3. Rising interest rates – this only applies to a HELOC where the rate is not fixed. It could make you have to pay back more than expected. 
4. Property devaluations – if your house declines in value you could end up with negative equity.
5. Lower credit score – leveraging equity may cause your credit score to decrease.

Home equity loans for all purposes

• Stuck paying high interest on credit card debts & loans?
• Looking to fund a home improvement project?
• Dreaming of finally taking the once-in-a-lifetime trip?

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Can you lose your house with a home equity loan?

The biggest pitfall when you take out a home equity loan is that you can lose your property if you fail to repay the cash. Because the equity is secured as collateral within the loan agreement, the lender has the right to make you sell your property and recover what they are owed in the event that you stop paying. This process is officially known as foreclosure. 

Missing one payment is not likely to result in foreclosure. Lenders generally work with homeowners to come up with solutions during periods of financial difficulty. This could mean reducing monthly payments but extending the loan so you end up paying back more. 

Is it bad to take equity out of your house?

Taking equity out of your home is sometimes seen as a very smart choice, and at others times, it is seen as a bad idea. Those in the first category view home equity as dead money not working for you and not being utilised effectively. Whereas those in the second group see using home equity as selling your home, brick by brick to be paid for again. 

The truth is that it can neither be a good or bad idea in generic terms. It all comes down to your personal situation and why you want the cash.