5 Reasons Not to Tap Into Home Equity

1. Interest Rates Are High

When the Federal Reserve hikes the federal funds rate, interest rates on home equity products also tend to rise. While lower than they were a year ago, rates are still relatively high. As such high borrowing costs may make tapping into equity less appealing right now. And, even in times of low interest, interest rates on home equity loans, HELOCs and cash-out refinances are typically higher than primary mortgage loans.

Keep in mind that most HELOCs—and certain types of mortgages—come with variable interest rates. That means you won't be protected from future hikes even if you take out the loans when interest rates are low. If rates rise significantly from when you refinance or access your home equity, making your payments could become more challenging.

Rates on loans and lines of credit can be even higher if your credit score is less than ideal. For these reasons, it may make sense to hold off on a home equity credit product until you're able to improve your credit or the Fed begins to lower rates (or both).

Learn more: How Does the Fed Affect Mortgage Rates?

2. You Want to Go on Vacation or Pay a Large Optional Expense

If you're considering using home equity to take a dream trip, fund a wedding or otherwise treat yourself, it may not be the best strategy. While these expenses may be important, they don't improve your financial health.

Taking on debt for discretionary spending isn't ideal. The best-case scenario for borrowing money is when it helps you grow your wealth or improve your overall financial position. For example, a mortgage can help you buy a home that may appreciate in value over time.

So, think carefully before borrowing money to cover optional expenses. These experiences are short-lived, but the debt you incur can last for years or even decades. And, the money you spend on loan payments might be better spent elsewhere, such as for your retirement or building an emergency fund.

Learn more: Pros and Cons of Home Equity Loans

3. You Want Use Home Equity to Pay College Tuition

While you may be able to use a HELOC or home equity loan to pay for college, it might not be a good idea.

You likely have better options to pay for higher education than leveraging your home's equity. Options that will cost you nothing or come with lower rates include:

• Scholarships
• Grants
• Federal student aid

Aim to exhaust these sources of funding before turning to more costly loan options like private student loans or home equity loans. You don't have to pay back federal grants and scholarships, and federal student loans generally come with lower interest rates than home equity financing—in addition to offering flexible repayment plans and potential student loan forgiveness.

Beyond differences in cost, it's also essential to bear in mind that failing to make payments on a home equity loan or line of credit exposes you to the risk of foreclosure. Given the risks, tapping your home equity to pay for school may not make sense.

Learn more: How to Pay for College When Financial Aid Isn't Enough

4. You Want Use Home Equity to Invest

All investments come with a certain degree of risk, but risking your home to invest in real estate or the stock market is not your best option.

While leveraging home equity to purchase rental properties may work out for you when rates are low and property values are rising, it's no guarantee. As consumers saw during the housing crisis in the mid-2000s, when home prices crash, people can become financially trapped in a home that's worth less than what they owe on it.

Similarly, using your home equity to invest in the stock market is a risky endeavor. Even for experienced investors, the stock market can be highly unpredictable. If your investments take a hit, you could lose the home equity you've invested and still be saddled with the debt.

Learn more: What Happens to Your Home Equity if the Value of Your Home Drops?

5. You Plan to Buy a Car With Home Equity Proceeds

Home equity loans and HELOCs once offered much lower interest rates than car loans. But according to the most recent data from Experian's State of the Automotive Finance Market report, the average interest rate on a new car loan is 6.73%, which is similar to or even lower than interest rates on some home equity loans and HELOCs.

However, the repayment term length makes a significant difference to your bottom line. Auto loans are usually paid off within five or six years, while home equity loans can take up to 30 years to pay off. That means you could pay much more in total interest over the life of the loan, even though the interest rates may seem similar at first glance.

Remember, cars depreciate quickly, with most vehicles losing roughly 20% of their value within the first year. If you take out a long-term home equity product to buy your car, you could end up owing much more than the car is worth and continue to pay it off long after you've stopped driving it.

Alternatives to Tapping Into Home Equity

Given the potential risk of foreclosure associated with home equity loans, it's crucial to explore other saving and financing options that don't put your home on the line, such as:

• Set up a dedicated savings account. Set up an automatic transfer to a dedicated high-yield savings account to set aside money for specific expenses like a vacation, wedding or car. Small deposits can add up over time and help you cover a significant expense without risking your home.
• Borrow from a close friend or relative. Borrowing money from someone you know can be uncomfortable, but it often provides the most favorable terms. Help to safeguard your relationship by setting up a written contract that outlines the loan amount and repayment schedule and then honor your agreement.
• Direct unexpected windfalls toward savings. Whenever you receive unexpected money, like tax refunds, work bonuses or an inheritance, allocate some or all of it towards your goal.
• Explore opportunities to earn extra income. Consider ways to earn extra money, such as a part-time job or side hustle, volunteering for overtime at work or selling items you no longer need.
• Consider other finance options. Most personal loans are unsecured, meaning you don't have to provide collateral such as your home. While unsecured loans have higher interest rates than home equity loans, they don't put your house at risk. Likewise, if you have good credit and want to consolidate your debt, a balance transfer credit card with a 0% introductory APR offer could be an option. With intro periods lasting as long as 21 months, you'd have a considerable window to reduce your debt without interest charges and without risking your home.

The Bottom Line

While home equity products can be valuable tools to gain access to the cash you need, the risk you take on is considerable. Before you tap into home equity for any reason, carefully evaluate the risk. Be aware that if your circumstances change and you can't make your payments, you could potentially face foreclosure and lose your home.

If you do decide to take out a home equity loan, line of credit or cash-out refinance, check your credit report and FICO^® Score^Θ for free with Experian to get an idea of your current credit status. Consider taking steps to improve your credit before applying for a new loan.