4 times you should get a home equity loan (and 4 times you shouldn't)

If you've been comparing your loan options in today's economy, you're well aware that borrowing money comes with a hefty price tag right now due to interest rates being elevated across the board. What you may not realize, though, is that while the average rates on credit cards and personal loans are sitting in the double digits, there are still a handful of relatively inexpensive borrowing options available. 

And, one of the best right now is a home equity loan. After all, not only do homeowners have high levels of home equity currently, but the average home equity loan rates are low compared to many alternatives. So, with home prices soaring over the past few years, the average homeowner is now sitting on nearly $300,000 in home equity currently — which can be borrowed against at a rate less than 9% on average. 

In turn, many homeowners are now opting for home equity loans as their preferred borrowing method. And, for the right person in the right circumstances, a home equity loan can make a lot of sense as an affordable way to access funds. However, a home equity loan isn't the right move in all cases, so it's important to understand when you should, and shouldn't, take advantage of this borrowing option.

Here's what a home equity loan could cost you if you borrow now.

4 times you should get a home equity loan

Here are a few times it makes sense to consider a home equity loan:

When you want a fixed, predictable rate on the money you borrow

Home equity loans are an attractive borrowing option because they provide a fixed interest rate for the life of the loan, versus the variable rates that come with home equity lines of credit (HELOCs), which can fluctuate over time and can cause payment amounts to swing month-to-month. This fixed-rate structure gives you a clear understanding of your costs and payment schedule from the outset. So, if you're seeking payment predictability, this aspect of home equity loans can be a big benefit.

Compare today's best home equity borrowing rates here.

When you need to borrow a large sum of money

Home equity loans allow qualified borrowers to access substantial amounts of money at relatively low interest rates compared to other loan types. While maximum loan amounts vary by lender, many will allow borrowing up to 85% of your home's equity value. So for those who need to borrow $50,000, $100,000 or more for a major expense, a home equity loan can be an ideal solution, provided you meet the borrowing qualifications.

When you want to consolidate high-interest debt

With rates on credit cards, personal loans, student loans and other debts as high as they are right now, it makes sense to lower your interest rates if you can. And, one of the most effective uses of home equity loans is to consolidate and pay off outstanding high-interest debts like these. By consolidating multiple high-interest obligations into a single, lower-interest home equity loan payment, you can reduce your overall interest costs and potentially become debt-free years sooner.

When you're confident you can make the monthly payments

Since home equity loans require putting up your home as collateral, ensuring you have a reliable, sufficient income stream to keep up with the additional monthly obligation is crucial. Lenders will closely examine your income, debts and creditworthiness during the underwriting process, which is a good start for determining whether you can afford to borrow this way. But you should also be honest with yourself about whether you can truly afford the new loan payments on top of your existing bills and living costs.

4 times you shouldn't get a home equity loan

And, there are a few times that a home equity loan may be the wrong choice, including:

When you're using it to bail out of bad habits

A home equity loan can help you consolidate debt at a lower rate, but it won't fix long-standing debt issues or a spending problem plaguing your household finances. If your debt issues are caused by this type of problem, using a lump-sum loan to pay off your debts will only reset the clock until those balances potentially accumulate again in the future. And, if you don't address the root overspending causes, a loan can make an upside-down budget even more unsustainable.

When you need money to buy things you don't need 

Ideally, home equity loans should be used to finance major one-time needs, purchases and investments that will pay off or increase in value over time. They should not be used as a money pool to fund discretionary, recurring expenses and wants like luxury vacations, frequent shopping splurges or other frivolous expenditures that will drain the funds without any lasting return.

When you're planning to sell your home within the next few years 

Since home equity loans typically have a term of five to 10 years with full repayment due by the end date, you may not have enough time remaining in the home to fully benefit and recoup the costs of taking out the loan if you plan on selling in the near future. In these cases, you should consider the loan's term versus your expected ownership timeline.

When you expect interest rates to drop in the near future

If signs are pointing to interest rates declining over the next six to 12 months, taking out a fixed-rate home equity loan now could mean locking yourself into a higher rate than if you waited. In this scenario, a HELOC may be a better option.

Unlike home equity loans where you receive funds in a lump sum, HELOCs provide you with a revolving credit line to draw from as needed, similar to a credit card. More importantly, HELOCs come with variable interest rates that fluctuate based on the wider rate environment. So if interest rates drop in the future, your HELOC payments would decrease accordingly, helping you save on borrowing costs.

The bottom line

Before tapping into your home's equity with a home equity loan, be sure to carefully assess your short- and long-term financial situation to determine if a home equity loan is truly advantageous for your needs. When used responsibly, home equity loans can be a powerful financial tool. However, they require prudent planning and monitoring to avoid putting your most important asset – your home's equity – at unnecessary risk.