Building equity is a major benefit of owning your own home. Equity refers to the portion of your home's value that you own, as opposed to the portion that is owned by the mortgage lender until you pay it off. Having home equity gives you the chance to borrow against that equity, but home equity loans carry several risks and drawbacks.
Loss of Equity
Losing the equity that you've built up in your home is the biggest problem with taking out a home equity loan. The longer you've been paying your mortgage, the more equity you'll have, especially if you've been paying above the minimum monthly amount. You can undo years of equity building with a single home equity loan, giving up the chance to borrow again in the future and passing ownership of your home back to a bank or lender.
Home equity loans charge interest, which means an additional payment for you as you repay the loan. Interest rates, along with repayment schedules, vary by lender and by the amount you borrow. Whatever the terms are, your home equity loan will cost you money. If you have cash savings or investments, it may be more prudent to sell them or use your savings to fund major expenses instead of taking out a home equity loan, especially if the loan rates available to you are high.
Taking on any type of debt increases the risk that you won't be able to repay it as you plan to, and this is certainly true of home equity loans. If you're still paying off your mortgage, a home equity loan means two large monthly payments, in addition to your routine bills and expenses. Failure to make timely payments on your home equity loan will result in penalties, fees and, in extreme cases, foreclosure.
Credit History Impact
A home equity loan becomes part of your credit history alongside your mortgage history, credit card accounts and other loans. Late payments or trouble repaying a home equity loan can damage your credit score, making it difficult to borrow money or qualify for low interest rates in the future. Even if you keep your loan current, the debt from a home equity loan will weigh on your credit history and make other lenders see you as more of a risk, as you have an additional financial obligation.