What happens if you cannot pay back your home equity loan?

Getting a home equity loan is a viable option for some folks to “unlock” the appreciated monetary value of their property and get access to larger loans. A home equity loan can be a powerful financial tool for homeowners if used wisely. But remember, you are risking the roof over your family’s head by using your house as collateral.

Well, this article will answer all the crucial questions you must know before taking out a home equity loan and understand the consequences of defaulting on a home equity loan.

Does a equity loan need to be paid back?

When tapping the equity in your property, the lender bank will provide you with a single lump-sum cash payment for a specific amount of money. Now you don’t have to pay off the whole equity loan in one go. You can pay back the loan amount over a set period via equal monthly instalments.

Unlike a conventional housing loan where you can service your repayments with cash or your CPF savings, an equity loan can be repaid only with cash. Therefore, borrowers need to have adequate cash flow every month to look after their home equity loan repayments.

The attractive part about home equity loans or cash-out refinancing is that you get much more favourable interest rates in comparison to unsecured loans like personal loans, renovation loans, education loans, business term loans, etc. Plus, you have the freedom to use your money for whatever things you may want.

Did You Know? Banks can even offer an equity home loan even if your current home loan isn’t paid in full. However, the amount of loan you can get may vary.

What do most people use home equity loans for?

Home equity loans are an easy way to free up extra cash while taking advantage of low-interest rates. There are no real limitations of how you can use your home equity loan (except a few), so people tend to use home equity loans in a lot of different ways.

Invest the capital elsewhere. As the loan is secured by your property, the interest rate is much lower (between 1% to 2%) than other types of unsecured loans. Therefore, you may want to invest the capital elsewhere to receive dividends or higher returns. Even your CPF funds would grow faster than this loan.

While some people tend to do so, we don’t advise making such investment decisions without taking guidance from a financial expert or qualified wealth manager.

Start a business or pay for big expenses. Banks and financial institutions offer several types of home equity loan packages. You can use cash secured from a home equity loan to get the initial capital outlay for starting a business.

You can also use the loan secured to pay for large expenses, such as home renovation, financing a vacation, sending your children for education overseas or even purchasing a vehicle. However, not all of these are the best uses for a home equity loan. It is best to use the money for things that add value to your home, for example, time-to-time home improvements.

Consolidation of multiple debts. People can also use a home equity loan to help consolidate their high-interest debts into a single cheap loan.

For example, say you have taken a personal loan of $45,000, a credit card loan of $35,000, a business loan of $50,000, and a car loan of $25,000. Since all these are loans with a high rate of interest ranging between 5% to 15%, it is best to repay all these loans at once using the home equity loan and then pay it back to the bank at a much lower interest rate.

Financial emergency. A home equity loan can be a great support when handling a financial emergency. For instance, if you are cash-strapped or need cash due to a serious medical condition, legal proceeding, or any unforeseen life event that requires big expenses, a home equity loan can come out as a saviour.

But the most interesting part is that you are getting a chance to cash out your house without having to sell it.

While you may get an equity home loan if you fulfil all the criteria, remember it is not the most accessible option for everyone. Although it is possible, the approval process can be tedious, and affirmation is highly conditional, depending on the bank you have applied to.

DollarBack Mortgage consultants can help you select a specific bank with the highest approval probability as well as the best home equity loan package available to you based on loan eligibility.

What can you not use a home equity loan for?

Using home equity doesn’t work for everyone in every situation. Before you commit to securing a home equity loan, consider the risks and rewards as well as other loan types that might work better for you.

According to the Monetary Authority of Singapore’s guidelines, you cannot use home equity loans as a way to gain funds for another house. This means that although you can use a home equity loan to pay off an outstanding housing loan, you are not allowed to take up a home equity loan to add another property either for yourself or for your children.

As a property owner, in the case of home equity loans, you are allowed to borrow as much as 75% of the property value. However, the final loan amount would need to minus any outstanding loans along with any CPF savings used for the property purchase. This means your home equity loan is not a cheat code to cash out your CPF funds.

What is the downside of a home equity loan?

A home equity loan is undoubtedly a fantastic way for homeowners to take out a bank loan at much lower interest rates, depending on the value of the home they own. But it has its downsides too.

The biggest drawback is that your property ownership is held as collateral. If someone has multiple properties, this might look acceptable. But if the property being used as collateral is the only roof over your family’s head, it is just too risky. The potential risk of losing your home makes a home equity loan very risky for the borrower.

Another downside to an equity home loan is early payment penalties. Some banks may penalise homeowners for repaying their equity loan before the fixed termination date.

Keep a note that home equity loans can be taken out against private properties only and are not available for HDB flats. Plus, the borrower must have owned the property in question for 1 year at least.

Is a valuation required for a home equity loan?

Yes! Your bank or financial institution will likely order a property valuation before granting you a home equity loan. An appraisal helps the lender ensure that they are not lending more money than the property is worth and thus protecting themselves from the risk of default. It also helps the lender to determine a borrower’s loan-to-value (LTV) ratio.

During a home appraisal, a licensed and independent appraiser does a comprehensive inspection of your property to evaluate its true value. The appraiser considers different factors that could have an effect on the property’s value, including the condition and size of the property, location of the property, any renovations or add-ons made to the property, and so on.

Upon compiling all the findings into a detailed report, the appraiser generates the appraised value of the home, which is also the basis of the borrower’s eligibility for a home equity loan.

Please note that valuation cost along with legal fees for an official valuation could cost anywhere between $2,000 and $3,000 upfront, depending on your property type. So, you must factor that into your total cost of borrowing alongside interest.

Also, it can take up to a few months in processing, so you need to be a little patient. Generally, it takes about 2 months in the approval process and up to 4 months if you have an outstanding home loan with the bank.

Is it bad to take equity out of your house?

Taking out equity may work well for older people looking to add some extra cash for their retirement years. This will allow them to can pay for costs of care, help a younger family member struggling financially, pay off their outstanding debts or even make home improvements.

But equity release may not be a good idea for everyone. Someone who lacks financial discipline may not be able to eliminate the temptation to spend the funds on unnecessary luxuries. Also, note that taking up a home equity loan decreases the amount of equity you have in your home, which affects the amount you can borrow.

You may be getting a significantly high amount of cash at favourable interest rates, but at the end of the day, a loan is a loan. Even though the interest rate is relatively low, it is still extra debt with interest. Don’t take a home equity loan for frivolous purposes given the severe repercussions of not repaying the loan.

Treat it as you would treat a housing loan as your home is at stake. If you are not growing the borrowed money in one way or the other, you will end up paying more cash over the long run for borrowing the cash against your property today.

Banks are able to offer lower interest rates because the loan is secured by property, and the stakes of not repaying are also high – you may lose the roof over your head.

What can happen if you are unable to pay back an equity loan?

If you are eligible for an equity loan but not sure if it is the best option for you, you should consider talking to one of our mortgage consultants as failing to repay the loan can have detrimental consequences that go beyond bad credit scores.

But ‘what can go wrong?’ you may ponder.

When the real estate market drops significantly due to any reason, homeowners who opted for an equity home loan may end up owing more money to the bank than the remaining value of their homeownership.

In other words, if you take out a home equity loan and the value of your home declines (since you bought the home), you could end up owing more than what your home is worth. This can make it more difficult for you to sell your home if you need to.

The maximum loan tenure for home equity in Singapore is typically 75 years minus your current age. If you are servicing a home loan currently, simply minus the total number of years spent servicing it.

For example, if you are 50 years old and servicing a home loan for 10 years, then your maximum loan tenure can be 15 years. However, different banks can slightly differ in how they calculate loan tenures.

What happens if you die with a home equity loan?

Equity loan borrowers may sometimes die (morbid but true!) with unpaid debts. Upon the borrower’s death, a home equity loan agreement typically ends. If the house is going to an heir or family members are hoping to inherit the legacy, the debt will be passed down to them if they wish to retain the property, and the bank may work with them to take over the loan payments.

But that’s not given. Some banks may insist the heir or family members repay the loan in full instead of assuming monthly payments for the home equity loan. If the heir lacks funds to settle the loan, they may be asked to sell off the home immediately and use the sales proceeds to pay off the bank’s outstanding loan then.

Can you lose your house with a home equity loan?

A home equity loan is secured by your house. So, it goes without saying that if you miss or fail to make payments and default on your equity loan, you can put your home in jeopardy. Be ready to face disastrous consequences, such as your lender foreclosing on your home.

The lender will have the right to repossess your house, and since your house was placed as collateral for the loan, they can even sell it off to fulfil the remaining debt and recoup its costs. If you don’t use a home equity loan carefully, the worst-case scenario could leave you and your family without a roof over your head.

If you don’t feel that a home equity loan is the right option for you, you could choose other forms of credit too, like a home equity line of credit (HELOC in short), which might work better for you as a financing option. Unlike home equity loans, it is a revolving line of credit that you can tap into on an as-needed basis.

This type of equity line of credit works well for those who don’t want to borrow a lump sum all at once or don’t know exactly how much they need to borrow, like for home renovations or any big, unforeseen expenses.

With a home equity line of credit, you pay interest only when you use the facility, unlike a home equity loan where the bank immediately charges interest once the loan is disbursed. It is recommended to talk to a qualified financial expert before choosing the type of home loan you need.

Final thoughts

Home equity loans can be a great way to get the much-needed capital for your business or investment portfolio. We, at DollarBack Mortgage, can help you get the maximum possible cash-out amount for your private property at the lowest interest rates.