Is a $250,000 home equity loan risky? Experts weigh in

The homeownership world has taken numerous unprecedented turns over the past five years. Home values shot up during the pandemic to record levels. Mortgage rates fell below 4%, making borrowing as affordable as it had been in years. Thanks to the combination of cheap funding and soaring values, many homeowners are now enjoying substantial levels of home equity (the difference between what your home is worth and what you owe on your mortgage). 

The average homeowner has $313,000 of equity in their home right now, representing a 6% increase year over year. With all that equity built up, homeowners are looking for ways to tap into that value, often turning to home equity loans and home equity lines of credit (HELOCs). Home equity loans offer a fixed rate and monthly payments, whereas HELOCs have a variable rate with monthly payments that fluctuate and, as a line of credit, allow you to borrow as needed, up to your limit. 

For borrowers who want the consistency of an interest rate and monthly payments that don't change, a home equity loan is a good fit. Furthermore, home equity loan rates are relatively low right now, with the average rates for 10- and 15-year loans at 8.50% and 8.44%, respectively. Even with relatively low rates and consistent monthly payments, though, a home equity loan can be isky depending on several factors. Risk becomes even more important to consider when you're borrowing a sizable amount such as $250,000. So, if you're ready to get a $250,000 home equity loan, how risky is it? We asked some experts to weigh in. 

See what home equity loan rate you could qualify for now.

Is a $250,000 home equity loan risky?

For many people, taking out a $250,000 home equity loan will be an unprecedented move, says Ralph DiBugnara, president of mortgage broker Home Qualified. "In most people's cases, it's going to be the most amount of money they have at one time," he says. How much risk that money represents has a lot to do with how you plan to use the money and what shape your finances are in when you receive it. 

When you're using it to pay off higher-interest debt: Less risk

A $250,000 home equity loan isn't as much of a risk if you're using the money to pay down higher-interest debt. Credit card balances are a good target for your home equity loan funds, DiBugnara says. 

"I think that most people are paying in the [20% range] for credit card debt which could drown you over time," he says. "If you're using that home equity loan to pay off credit card debt with high interest rate … you're putting yourself into a better situation with a lower overall payment — that's definitely advantageous."

However, be smart about your borrowing, advises Kevin Leibowitz, president of mortgage broker Grayton Mortgage. If you free up extra cash in your budget by paying off higher-interest debt, don't use that added cash flow as an opportunity to borrow more money. 

"If you're doing the debt consolidation and you paid off a bunch of debts and made yourself better on a cash flow and interest rate basis, stop there," he says. 

Consider paying down your debt with a home equity loan now.

When your mortgage and home equity loan payments make up more than 30% of your budget: More risk

Generally speaking, a homeowner's mortgage payments should make up 30% of their budget, says Dr. Severine Bryan, founder of financial education and coaching company Sev Talks Money. 

"I know that conventional wisdom is 40%, but with the way things are these days, I suggest no more than 30% of your take-home pay on home costs," she says. 

Why the 30% limit? A lot of it has to do with the uncertainty that the economy and job market are facing right now, Bryan says. Keeping your housing costs low gives you extra cash in your budget that will be helpful if inflation drives up the prices of everyday goods and services or you run into a financial emergency.

"Give yourself some breathing room," she says. "Even though conventional wisdom says 40%, don't max that out … Just to be safe, you may want to keep your mortgage and loan to the lower end just to give yourself some wiggle room."

You have a reason and a plan for your loan: Less risk

Knowing why you're taking out your loan and how you're going to adjust your budget accordingly can go a long way in ensuring you're borrowing responsibly, Bryan says. 

"You want to make sure you have a plan," she says. "Before you even get the loan, lay out your finances. What can you afford? What are the risks? What are the pros and cons? Having that solid financial plan [means] if something negative happens, you've already anticipated what that negative could be, to a certain extent."

Identifying what you'll use the money for and how you'll make the monthly payments work creates intentionality that can guard against overborrowing, DiBugnara says.

"What is the plan for the money in general," he asks. "Look at your personal budget and ask if you can afford to take out this money. I think that's very, very important." 

You're maxing out the equity in your home: More risk

One of the metrics that lenders use to determine your home equity loan rate is your combined loan-to-value ratio (LTV), Leibowitz says. Combined LTV refers to the combined percentage of your mortgage and, in this case, home equity loan compared to your home's value. If your house is valued at $500,000 and your mortgage and home equity loan balance is $250,000, your combined LTV is 50%, he says.

The higher your combined LTV, the more risk it presents to banks, and the higher your interest rate might be.

"Lenders like a lower combined LTV," Leibowitz says. "The lower the combined LTV, the better terms you get as a borrower. "

If you push your combined LTV to the maximum of what your lender allows, your rates could go up, which means your monthly payments will be higher than if you had a lower combined LTV, Leibowitz says. Higher monthly payments increase the chance you may not be able to afford your debt, which might lead to foreclosure if you default on payments. 

"If you don't have the ability to pay that, then you're at risk of losing your home," he says. 

The bottom line

Taking out a $250,000 home equity loan is a big responsibility. Don't take a bank's approval of your loan application as a sign that you can handle the monthly payment, DiBugnara says. When a bank considers your financial ability to repay your home equity loan, they're not always considering your entire financial situation, he says. 

"When a bank qualifies you for a loan, they're not counting a lot of your [bills]," he says. "They don't look at your electric bill, your cell phone bill, your car insurance. There's a lot of other things in your life you're paying for they're not considering." 

Remember that you know your finances best and, if you haven't updated your budget in a while, take a moment to refresh your numbers and make sure you can afford your monthly home equity loan payment, particularly when borrowing a large sum like $250,000.