The fact that home values have soared in recent years is a bad thing for today’s buyers. But it puts existing homeowners in a stronger financial position.
U.S. homeowners are now sitting on almost $30 trillion in home equity collectively, according to the St. Louis Federal Reserve. That amounts to roughly $200,000 per homeowner in tappable equity — meaning, the amount of equity you can borrow against in order to still maintain 20% equity in your home.
If you’re sitting on a pile of home equity, you may be tempted to tap it via a home equity loan or line of credit (HELOC). But before you go that route, consider the pros and cons.
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Why it could pay to tap your home equity
Some people tap their home equity to do things like renovate their home. You can also borrow against your home for a purpose having nothing to do with your home, like taking a vacation. But it’s generally best to reserve a home equity loan or HELOC for situations where you’re borrowing money to greatly improve your life — such as finishing a basement to add living space to your property or paying for a course that can help you grow your career and boost your income over time.
The upside of tapping home equity is that it can be fairly easy to qualify to borrow, provided your credit is in reasonable shape. The reason? Home equity loans and HELOCs are secured by the homes being borrowed against. If you fall behind on your payments, your lender can eventually force the sale of your home to get repaid. That minimizes your lender’s risk — even though it adds to yours.
The problem with tapping your home equity — today and in general
Generally speaking, borrowing against your home equity means putting yourself at risk of losing your home. This won’t happen if you make your payments on time as you’re supposed to. But who’s to say that you’ll be able to do that? What if you lose your job or something else happens that makes it so you don’t have a paycheck for a while?
If you’re going to borrow against your home equity, make sure you understand the risks involved. And don’t take on payments that are a stretch to begin with.
You may want to consider a personal loan as an alternative to a home equity loan or HELOC. Personal loans are unsecured, so they’re not tied to a specific asset. Falling behind on one is still a bad thing, as it could ruin your credit. But you’re taking a different risk there — one that doesn’t necessarily involve losing the roof over your head.
Of course, following the Federal Reserve’s recent string of interest rate hikes, borrowing money in any form is pretty expensive these days. So for that reason alone, you may want to hold off on tapping your home equity and wait for interest rates to come down.
But if you decide to move forward with a home equity loan or HELOC, shop around with different lenders to see which has the most competitive rates. And read the terms of your borrowing agreement very carefully so you know exactly what you’re signing up for.