Home Equity Loans can be Risky Business

Leveraging your home equity can be an easy, affordable way to borrow lots of money. Make sure that the risks don't outweigh the rewards.

When you're about to close a home equity loan, you might feel like doing the Risky Business dance that made Tom Cruise famous. If you have the moves, go for it. Just remember that when Tom's character, Joel, parades around the house in his briefs, he's sweetly unaware of all the trouble he's about to stir up.

Home equity loans are easy to get, and easy to budget. Tens of thousands of homeowners have used them to finance home remodeling, business start-ups, college tuition, debt restructuring, medical expenses, and dream vacations. But it hasn't all been fun and games. According to a quarterly consumer loan survey by the American Bankers Association, late payments on home equity loans are on the rise. As more homeowners are having trouble making their equity loan payments as scheduled, it's a good time to consider just how risky home equity loans can be.

Losing it all

Borrowing against your home equity increases your risk of losing the home in a foreclosure. No doubt you already knew this-just like you know that general anesthesia can have fatal consequences, or that airplanes can sometimes crash. All three are things you might file away as "stuff that only happens to other people." The reality is that no one expects to lose a home, declare bankruptcy, or incur interest rate increases or late payment fees. But every home equity borrower should consider that these consequences are very real possibilities.

While there's no way to eliminate risk from a home equity loan, you can do some things to minimize it. First, ask yourself why you're taking on this debt, and whether it justifies making payments for the next 10, 20 or 30 years.

One area that's particularly challenging is debt consolidation. Are you consolidating with a home equity loan to get the credit cards off your back? Are you delaying or avoiding changing your spending habits? Or is the debt consolidation part of a lifestyle change to help you undo years of overspending? Consolidating for the wrong reason may literally send you packing out of your home if you can't meet the payments and the bank forecloses.

What if?

Secondly, prepare yourself for an uncertain future by making regular deposits into an emergency cash fund. Maybe you can afford those extra loan payments today-but what if you lose your job? What if your household expenses increase dramatically? What if the home's value drops and you have to come up with cash to cover the shortfall? If you have no emergency cash and your budget doesn't allow you to save, it's probably not a good idea to take on the extra debt.

Do the Tom Cruise dance in whatever outfit you choose. But don't take on the risky business of a home equity loan without thoroughly considering the downside.