A home equity loan can be a good idea if you need to unlock immediate cash at a lower rate, especially compared to unsecured financing. Leveraging your equity can be a lifeline if you’re faced with unexpected medical bills or a major home renovation.
But you’ll need to decide if borrowing against your home aligns with your financial goals and risk tolerance. Home equity loans don’t come without risk and have to be repaid eventually. We’ll walk through scenarios where a home equity loan might make sense and compare other equity-based financing options.
Signs a home equity loan might be a good idea for you
- Your income is reliable. You have a steady income that’s enough to support the new loan and your existing mortgage, bills, and other debts.
- Your budget isn’t maxed out. You consistently keep your debt-to-income ratio low (ideally 36% or lower), and your monthly budget will still have breathing room—despite adding a new home equity payment to the mix.[4]
- You’re borrowing for a reason. The loan is for a specific purpose that improves your long-term financial outlook. This might include paying off high-interest debt, starting a business, or increasing your home’s living space with a new addition.
- You can land softly in an emergency. You have a rainy day fund to temporarily cushion you from unexpected financial hardship. If an unplanned expense or a sudden job loss comes up, you have a runway to get back on your feet without immediately risking foreclosure.
If you’re uncertain about any of these areas, borrowing against your home can compound an already stressful financial situation. Talk to your loan officer about your personal financial details to ensure a home equity loan is a good choice for you.
Signs a home equity loan might be a bad idea for you
- Your income is inconsistent or declining. Let’s say you’re a full-time freelancer and your income is 40% lower month over month, and it keeps trending downward. This instability might be challenging in repayment.
- Your cash flow issues run deep. If you’re using the funds to sustain everyday expenses, like routine car maintenance and groceries, you might be dealing with a systemic budget deficit.
- Your safety net is frayed. You don’t have sufficient savings to catch you during short-term cash flow disruptions. This can put your home at risk if you can’t make your home equity payments.
It’s important to keep in mind that equity is tied to home values. If a housing market downturn suddenly strikes, your home equity loan risks becoming “underwater.” You’ll owe more on the loan than your home is worth.
If you’re selling your home, having less equity can also make it harder to close on a sale without putting cash in for selling costs or reducing your profit. That said, a lot of the risk comes down to your personal financial profile. Bernie Frascarelli, executive loan officer at Best Interest Financial, says “The risks [of a home equity loan] are usually very slim, unless you don’t pay your bills.”
Make a plan for how you will use the home equity loan
Being intentional about the purpose of the loan is crucial. In some situations, borrowing against your home can create a strategic financial advantage. In others, it can present a costly burden.
Below are opposing scenarios that illustrate when a home equity loan can be a powerful low-interest financing tool versus a sinking ship.
Scenario 1: Saving on high-interest debt
Let’s say you have $40,000 in credit card debt with a 20% APR and you’re repaying it over 10 years. Your monthly payment would be $773. Such a large payment can be hard to manage, plus you’ll pay nearly $52,800 in interest over time.
Now, if you pay off the card balance using a home equity loan at a fixed 8% over 10 years, your monthly payment shrinks to $485. Your total interest over the term is also significantly less, at about $18,200. Overall, you’ll realize a monthly savings of $288, and a total interest savings of approximately $34,600 by using a home equity loan to consolidate debt.
Scenario 2: Depreciating or short-lived expenses
Assume that you have a couple of high-cost expenses coming up, like a new-to-you used car purchase and a vacation. Let’s say their combined total expense is $55,000. If you used a home equity loan at 8% for 10 years to cover these purchases, your monthly payment would be $667 with about $25,000 in interest paid over the term.
Technically, leveraging your equity toward these expenses saves money, compared to using a credit card. The major downside, however, is that these types of purchases lose their value quickly. Now, you’re left with a decade-long debt that puts extra strain on your budget, for expenses that have come and gone.
You’ve also put your home at risk if you unexpectedly get laid off from your job, or another emergency expense comes up. Before getting a home equity loan, be clear about what you’ll use the funds for and how it can strategically improve your financial outlook.
Is a home equity loan really your best option?
A home equity loan is just one way to tap into your equity. Other options include a home equity line of credit (HELOC) and a cash-out refinance.
Like a home equity loan, a HELOC creates a second mortgage against your home. It works like a credit card. You’ll have a maximum borrowing limit, which you can draw against as needed for a limited period.
A cash-out refinance replaces your existing mortgage loan with a new one and bakes in the cash-out equity you’re borrowing. This is a primary mortgage that borrowers typically choose to reset to a full 30-year term, though you can choose a shorter term. The cash-out equity is funded as a lump sum payout.
| Home equity loan | HELOC | Cash-out refinance | |
|---|---|---|---|
| Best for | A fixed, one-time sum | Flexible spending and ongoing access to funds | Combining mortgage loan and a fixed, one-time sum |
| How it’s funded | Large, upfront disbursement | Revolving line of credit | Upfront, cash-out only disbursement |
| Rate type | Usually fixed; can be variable | Variable; only applied to credit used | Fixed or variable; applies to entire loan balance |
| Rate | Slightly higher | Slightly higher | Lower |
| How it affects mortgage | None | None | Replaces original mortgage |
| Loan term | 5-30 years | 10-year draw period, up to 30-year repayment | Up to 30 years |
| Closing costs | Slightly lower than HELOC | 2%-5% of principal amount | 2%-5% of principal amount |
Talk through all your equity options with a pro
Our team at Best Interest Financial will help you figure out if a home equity loan makes sense for your situation—no guesswork, no confusion. We'll look at your complete financial picture, explain your options, and find the best financing strategy for your specific goals.
Whether you need a home equity loan, a HELOC, a cash-out refinance, or something else entirely, we'll work through the numbers with you and make sure you're confident in your decision every step of the way. Get started with a free quote from Best Interest Financial today.
FAQ about home equity loans
What happens to a home equity loan if you get divorced?
Liability for home equity debt depends on who's name is on the loan or property title, and the state you reside in. Spouses who live in a community property state are automatically equally liable for repaying the loan. In non-community property states, both spouses might still be liable for the debt, regardless of whose name is on the loan.
If they borrowed a home equity loan together or if it was used to benefit the marriage, both individuals might be on the hook.[1]
Is a home equity loan a good idea if you have a fixed income?
Yes, a home equity loan can be a good financing option if you have a fixed income. Home equity loans are a closed-end debt that can have fixed rates.[2] Monthly payments are generally predictable, if your rate is fixed, which makes it easier to budget on a fixed income.
Can I get a home equity loan if I already have a HELOC?
Technically, you can borrow a home equity loan even if you already have a HELOC. However, in practice, there are caveats. You’ll need to have sufficient equity remaining in your home to qualify for a home equity loan on top of a HELOC.
Additionally, you’ll need to meet the lender’s income, debt-to-income ratio, and credit requirements for the second mortgage.[3]
Disclaimer: The information provided in this article is for informational and educational purposes only. It is not intended as legal, financial, investment, or tax advice, and should not be relied upon as such. Mortgage rates, terms, products, and eligibility requirements are subject to change without notice and vary based on individual circumstances, credit profile, property type, loan amount, and other factors. All loans are subject to credit approval. This content does not constitute a commitment to lend or an offer of specific loan terms. For personalized mortgage advice and to discuss loan products that may be suitable for your situation, please contact one of our licensed loan officers.