Why You Should Never Use Your Home As Collateral

There will be cases when you think about getting a loan of some sort. Common occurrences include loans to buy a car, purchase a second home, finance home improvements, and so on. You need a large chunk of money, and it makes financial sense to spread the costs with loan repayments. 

Many loans are unsecured, but equally as many are secured – which means you need to present something as “collateral.” This will almost always be a valuable asset that the lender deems good enough to protect them if you default on the loan. Imagine you can no longer make repayments because you fall into financial distress; the lender can take your collateral asset and sell it to recover their losses. 

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In theory, you can use anything as collateral – though a lot of lenders and creditors will want your home. It’s your biggest asset, which means you’re more likely to do everything in your power to keep up with repayments, and it gives them a bigger safety net if you don’t. Some loans – like a home equity loan – are specifically designed to borrow against your property, but this is a much worse idea than it seems. 

Using your home as collateral for any type of loan is a terrible idea – and here’s why…

You Could Lose Your Home

The biggest worry is that you could lose your home when it’s put up as collateral. We all want to live with full financial stability at all times, but that’s not always possible. Market conditions could mean you lose your job or take a pay cut. Other emergencies can happen, demanding financial attention and eating into your budget. In any case, you could experience weeks or months where you’re unable to keep up with loan repayments. 

Depending on the terms of your loan, the lender could exact their right to claim your property. They look at your financial position and believe they’ll lose too much money if things keep going as they are. So, they seize your home and sell it to recover their losses. There’s nothing you can do about this if you don’t have money to repay what you owe – it’s completely legal, and you signed the contract. 

Why create such a dramatic risk? You worked hard to afford your home, yet using it as collateral almost feels like you’re no longer the proper owner. Someone else has their hands on your property and can take it if you fall behind on loan repayments. It’s not worth the stress or the risk of forcing your family to move.  

Your Kids Inherit The Issue

You might believe that getting a home equity loan or using your home as collateral for other things is a smart choice. You’re confident in your ability to repay a loan, so it doesn’t seem like a problem. But what if something happens to you before you pay it off? 

It’s not nice to consider, but imagine you pass away with payments still due. What happens next? Your kids have to deal with the problem! They inherit your home and have to handle all the issues during probate. This may result in them being forced to sell the probate property to get your old creditors off their backs. 

How would you like it if your parents effectively left you without their biggest asset? It almost feels like a betrayal, which is why using your home as collateral never makes sense. There are other people to think about, regardless of how it might affect you. In the end, the issue may never be yours to deal with; you leave it to your kids to clean up your mess and lose a highly valuable asset. 

You Might Lose Money From Your Home

When you use your home as collateral, it restricts what you can do with it if you want to sell and move elsewhere. Maybe you’ve grown out of your home and need a larger one for your family. Or, what if the opposite is true and you need to downsize to something smaller and more affordable?

Either way, selling your home can cause problems when it’s collateral. Lenders might put a clause in your contract that states you must repay the full loan amount if you sell your property. For example, let’s pretend you have a $100,000 loan and you sell your $400,000 house. You’d need to pay the lender $100,000 from the sale, effectively losing a quarter of your home’s value! 

Can you imagine how devastating this is? A huge chunk of money just disappears into thin air, which impacts your ability to buy your next home. The caveat to this is that some lenders will transfer collateral to your new home instead of forcing you to pay up. But is it worth the risk?

There Are Much Better Options Out There

Why bother using your home as collateral when there are way better choices to explore? Even in the secured loans market, you’ll find options that let you use things like your car title to back a loan. That’s far less risky than using your home and doesn’t have long-term financial consequences. 

More to the point, look at all the unsecured loan options out there. Those of you who need money to pay for something important can usually get what you need without putting anything up as collateral. Sure, you deal with much higher interest rates, but it’s better than living with a huge shadow over your head, thinking, what if something bad happens and you lose your home? 

When you gather all the information, it’s a simple case of the cons outweighing the pros. To be honest, there aren’t really any benefits to putting your home up as collateral other than maybe getting more favorable interest rates. It’s simply not worth the financial risk. You worked hard to buy your home and get a foot on the property ladder. This should be your biggest asset and most valuable investment, meaning you need to do everything you can to look after it and get the maximum amount of money from it in your lifetime.

This is a contributed post.

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