Home equity loan risks: Is borrowing against your property always wise?

Housing prices are climbing, but so too are levels of home equity. Many homeowners are tapping into theirs: The size of home equity line of credit balances ballooned by $9 billion in Q2 2025 to a collective $411 billion, according to the Federal Reserve Bank of New York. 

Borrowing against your homeownership stake can be smart, if you’re confident you can handle the payments and use the funds to increase your property value or your net worth. But there are a few important things to consider first. Here are the hazards of tapping your home equity, and how to avoid them — or at least minimize them.

Home equity loan risks

While all loans come with some risk, home equity financing is secured by your home, which means you should approach it with additional caution. Before tapping into your home equity, make sure you understand all the terms and conditions of the loan. Compare your household income to your monthly expenses to make sure you can afford the payments, and remember: If you’re still carrying a mortgage, you will now be responsible for paying off two loans.

There are two basic borrowing tools that use your home as collateral: home equity loans and home equity lines of credit (HELOCs). Though different, they involve similar sorts of risks:

• Your home is on the line: The stakes are higher when you use your home as collateral for a loan. By tapping into your home’s equity, you’re essentially depleting your ownership stake — transforming a valuable asset into a costly obligation. And unlike defaulting on, say, a credit card, defaulting on a home equity loan or HELOC could eventually allow your lender to foreclose on your home.
• Your home value could go down: When you tap into your home equity, you’re essentially reducing your ownership stake in your home. This can be a real problem if property values fall, as you might end up owing more than your home is worth — a situation known as negative equity, or being underwater. This can impede your ability to sell your home or refinance your mortgage. In addition, an economic recession (or fears of one), extreme weather events or even a sluggish job market could potentially impact the value of your home.
• Your interest rate could rise: Home equity loans typically have fixed interest rates, so you’ll know exactly how much your monthly payment will be for the entire loan term. But HELOCs generally have adjustable rates, which means that payments increase as interest rates rise. “The interest rate on a home equity line of credit is often tied to the prime rate, which will move up if there’s inflation or if the Fed raises rates to cool down an overheating economy,” says Matt Hackett, senior VP and head of operations at mortgage lender Equity Now. Because interest rates are unpredictable, HELOC borrowers could pay much more than they originally signed up for — especially if rates rise quickly, as they did in 2022.
• So could your payments: Many HELOCs allow lower, interest-only payments during their draw period, which typically lasts 10 years. But if you only make these minimum payments, you won’t make any progress in paying down your outstanding balance. After the draw period ends, the repayment period begins — if you withdrew a large amount during the draw period and only made minimum payments, you might experience sticker shock once the principal balance is added to your monthly bill. “A lot of people think, ‘I’m gonna take out a HELOC, it will be interest-only and cheaper in the beginning,’” says Yechiel Zeilingold, a loan officer with FM Home Loans, based in Brooklyn, New York. “Then 10 years down the line, everyone may have a hard time coming up with that money.”
• Your credit score can drop: Finally, opening a home equity loan can also affect your credit score. Your score is made up of several factors, including how much of your available credit you’re using — a large home equity loan can negatively impact your score by increasing the amount of available credit you’ve utilized. That could make it harder to qualify for other loans in the immediate future. For example, getting a home equity loan right before buying a car could mean a higher interest rate on the auto loan (because your score is lower, making you look less creditworthy) or even a rejection.

When not to use a home equity loan

While you can hypothetically use home equity loan funds for anything you want, that doesn’t mean you should. A home equity loan could be a good idea if you’re using the funds to make home improvements or consolidate debt with a lower interest rate. However, it’s best to avoid using home equity in the following scenarios:

• To cover everyday expenses: It’s generally not wise to resort to a home equity loan if you need funds to help resolve day-to-day money shortfalls in your budget, says Steve Sexton, a financial consultant and CEO of Sexton Advisory Group in Temecula, California. After all, a home equity loan still needs to be repaid, and failure to keep up with payments could send you deeper into debt. “If you’re hoping it will help your cash-flow problems, it will likely do the opposite if you don’t have a structured plan to pay back the loan,” he says.
• To buy a car: Using home equity funds to purchase a new car is also typically not a great idea. Unlike homes, cars tend to be depreciating assets — they have no long-term value, says Sexton. And odds are you’ll be paying them off long after their value has diminished. 
• To fund a vacation: No matter how tempting it may be, don’t take out a loan — and put your home at risk — to pay for a vacation. It’s better to start a vacation-specific savings fund instead. The same goes for holiday gifts and expenses. “Using home equity loans to fund leisure and entertainment indicates you’re spending beyond your means,” says Sexton. “Using debt to fund your lifestyle only exacerbates your debt problem.”
• To invest in real estate: Putting your money to work by investing can be smart, but going into debt to invest is debatable. Real estate is particularly speculative and, more importantly, highly illiquid, meaning it cannot quickly be sold without a loss in value. Even if your real estate investment goes well, it can take years to realize any appreciation, and it will take time to get your money back out in order to repay your home equity loan. The one exception might be to use home equity to buy an adjacent property or lot, as the extension arguably enhances your home’s value.

Using home equity funds to pay for college

This one is not so much a total avoid as a consider-very-carefully. Earning a college degree can be considered an investment in your or your child’s future, in terms terms of skills and career opportunities. And using home equity loans can be a smart strategy, especially HELOCs, which are tailor-made for expenses incurred in installments over a long time period. You can just withdraw what you need for each semester’s tuition and only incur interest on that particular amount. You can also start paying it back right away, rather than being hit with a mountain of debt after graduation.

But there are other ways to pay for college that don’t risk potentially losing your home. And what’s more, interest rates on federal student loans are lower than those on HELOCs and home equity loans.

How to protect yourself from home equity loan risks

If you do take the home equity loan plunge, here are some tips to go about it intelligently.

• Don’t borrow more than you need: Don’t just automatically tap the maximum amount of equity you can. Try to calculate exactly how much you’ll need — perhaps with a bit extra, depending on the expense — and limit your loan to that. If you’re getting a HELOC, figure out how to time your draws in advance. Before you apply for any product, it’s a good idea to crunch numbers with a financial advisor to see how much you can afford to borrow and comfortably repay each month.
• Create and stick to a budget: Tapping into these funds can make it feel like you have a huge new cash pool to play in, which makes it easier to spend superfluously. When you get your loan, create a new budget that includes your new loan payment, so you can make good progress on paying down the balance. If you opted for a HELOC, make sure the budget includes payments for both interest and the loan itself. Remember: “It’s a mortgage. It’s not a credit card; it’s not a personal loan,” says JR Younathan, VP and state production manager for California Bank & Trust. You want to be as diligent in paying it as you would with your primary mortgage.
• Choose a fixed rate: Many lenders offer fixed-rate HELOCs and HELOC conversions. This gives you a chance to pay off or pay down your balance while the rate is locked. If you already have a HELOC with an adjustable rate, consider refinancing it to a fixed rate, if the lender allows it. You might also consider refinancing your HELOC into a home equity loan. That will protect you from unexpected shifts in interest rates, which can increase your monthly payments. (Just be sure to read the fine print of your loan to make sure there isn’t a prepayment penalty.)
• Monitor your credit score: Keep an eye on your credit score, and be aware of how your home equity loan impacts it. Adding a new, large debt to your credit report will likely drop your score in the short term. Watch your score over time to see how it changes as you make payments or draw additional funds from your HELOC. If it drops significantly, consider pausing HELOC withdrawals or stepping up your efforts to pay off the loan.
• Shop around for the best rates and terms: Don’t settle for the first home equity loan or HELOC offer you receive. Compare rates, terms and fees from at least three lenders to ensure you get the best deal. Some lenders waive closing costs for loans of a certain amount or offer promotional rates, for example. As with any mortgage, even a small difference in interest rates can translate to significant savings over the life of the loan.

Is a home equity loan a smart move for you?

Some home equity lenders tout your ownership stake as a treasure that’s just sitting around, begging to be tapped. But the reality is that home equity loans are just that: loans. They create a debt that must be paid back, and they come with fees and interest, which can ultimately cost you thousands of dollars on top of your initial loan amount.

Despite these hazards, using home equity as a long-term investment in your home, to enhance its worth, can be a sound strategy. Before committing to a home equity loan, consider your budget and compare interest rates, terms and fees from a variety of lenders to see how much it could cost you.

FAQs

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Additional reporting by Maya Dolllarhide