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For many Americans, their homes are their most valuable asset. Homeownership can help to build wealth, both as your home's value increases and as you pay down your loan and acquire equity in your property.
Unfortunately, millions of Americans have taken a big risk that could jeopardize their homes. Collectively, homeowners across the country have gambled $362 billion. And many don't even realize the chance they've taken.
Here's how so many Americans have put their homes on the line
So what's the big -- and risky -- bet that Americans have placed? They've bet they'll be able to pay off home equity lines of credit. Home equity lines of credit, (or HELOCs) are a type of revolving loan that's guaranteed by the value of your home.
When you take out a HELOC, you use your home as collateral to gain access to a line of credit. The line of credit works similarly to a credit card, in that you can borrow up to a certain limit, pay the money back over time, and borrow again and again -- as long as you don't exceed your credit line. The big difference, however, is that your HELOC is guaranteed by your home while credit cards are unsecured debt.
According to The Ascent's recent research, Americans have collectively borrowed $362 billion in home equity revolving debt as of the third quarter of 2020. And each individual borrower with a HELOC generally owes a substantial sum, with the mean home equity line of credit valued at $49,929 as of 2019.
These balances are large because home equity lines of credit are popular among homeowners. They can provide flexibility, since you can access the line of credit as needed. And they tend to have a lower interest rate than many other kinds of debt.
But unfortunately, every time a homeowner takes out a HELOC, they're gambling they'll be able to make payments. If they can't, they risk foreclosure. After all, since the home guarantees the loan, it's relatively easy for the lender to take the home in case of a default. By contrast, a typical credit card or personal loan issuer could sue for nonpayment but isn't going to be able to seize and resell your home if you don't make the bills.
There's another huge risk to think about too
Tapping home equity isn't just dangerous because of the risk of foreclosure, though. It can also increase the risk of being unable to sell your home to cover what you owe.
Say, for example, you have a home valued at $300,000 with a $220,000 mortgage on it and you use a HELOC to borrow another $49,000. You'd be in OK shape if you had to sell -- if you could find a buyer to pay market value. Selling the home for $300,000 should give you enough to pay off your collective $269,000 in mortgage debt along with closing costs and a 6% commission to real estate agents.
But if property values fell even a little bit to, say, $275,000, you'd be in trouble as you likely wouldn't be able to pay off your mortgage and all the costs associated with selling the home.
And if they fell even further and your home was priced below the combined value of your loans, you'd really be in dire shape. You'd be stuck in your house unless you could bring tens of thousands of dollars of your own money to the table at closing. And that could be a big problem if you have to sell due to a job loss or other financial disaster.
Think carefully about putting your house on the line
There are some circumstances where it makes sense to borrow against the equity in your home -- such as for essential home improvements that will help to retain or increase value.
But you need to be aware of the risk you're taking. You might need to sell in a down market or face future trouble making payments. Unfortunately, millions of Americans who have collectively bet $362 billion may not fully understand the potential dangers associated with their choice. Don't let that happen to you.