Home equity loan: Should you take out a home equity loan to fund your financial goals?

The Khannas are looking for ways to raise funds as their business suffers due to the pandemic. They save for goals such as their son’s education, retirement and family vacations. The Khannas like to spend for a better standard of living and do so even when the budget is tight. About 10 years ago, one of the biggest investments they made was in a house, which they now live in. The house has gone up in value and the couple is tempted by the lower interest rate, longer term and smaller monthly repayments of a home equity loan. They believe they can use this locked-in value of their investment to achieve some of their goals and obligations. What are the factors they need to consider in doing this?

The Khannas must consider the consequences of their decision to cash in the equity in their property. Home equity is generally considered a nest egg to be used in retirement, if needed. If they use their home equity now, it could impact their financial security and ability to meet their retirement goals. They must also consider their ability to repay the home equity loan they will be taking. They must not increase their monthly obligations any further in this difficult period.

They should not consider this loan to meet consumer or lifestyle expenses. These can very well be deferred until they can meet them with their regular income, once the business is back on track. Moreover, they will simply replace an unsecured loan with a secured loan of a longer duration with more serious consequences in case of default. It must therefore be a well-considered decision. Where possible, they should consider other ways to supplement their income by exploring alternatives that might work in the prevailing scenario.

One way to manage the loan would be to use the funds to invest and earn a steady return to fill their income gap. However, this would require finding an investment that will provide a high enough return to cover the cost of borrowing and generate an additional return. If the investment does not perform well, it can put them in a situation where they have to bear the cost of the loan or lose their house and a worse financial situation than before. They should save the equity in their home as a reserve to deal with future emergencies, which may require a large expense or to finance an important goal if they are sure they will be able to repay the loan quickly.

(Content on this page is courtesy of the Center for Investment Education and Learning (CIEL). Contributions by Girija Gadre, Arti Bhargava and Labdhi Mehta.)

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