October 22, 2020
What Is the Best Use of a Home Equity Loan?
There are several benefits to leveraging the equity you have in your home. If home values have increased significantly since you moved in, the value of your home versus what you owe may provide you with more equity than you thought. Perhaps you've simply lived in your home for so long that you've paid down a great deal of principal. Whatever your situation, take a look at some of the ways you might want to use the equity in your home.
- Consolidate Credit Card Debt. Whether it's credit card debt or other high interest obligations, consolidating that debt by leveraging the equity in your home can be a great idea. Something to consider of course, is that a home equity line of credit, or "HELOC", is simply another form of a loan. Therefore, if you consolidate your debt under either a HELOC or a home equity loan, you basically exchange one form of loan for another. Make sure, therefore, to consolidate under a smaller interest rate than that on your original debt and understand the time it takes to pay back the home equity loan.
Using your home equity to consolidate your debt can save you money over time. It can also reduce your expenses now by spreading the payments out longer. One critical warning when consolidating revolving debt like that held by credit card companies is that it's often too easy to slip back into credit card debt; if you do so, you will end up with both home equity debt and credit card debt, a circumstance you want to try to avoid.
- Increase the Value of Your Home. There are a few ways to use your home equity to increase the value of your home whether you plan to move soon, or over time. For example, you might consider a major upgrade to the home in the form of a renovation. Some renovations add more value than others, so be sure to do your research when looking for renovations that fit your home, lifestyle, and home ownership plans. Some typical home renovations might include updates to the following:
- Kitchen and appliances
- An office or closets
- The curb appeal of your home via exterior upgrades, a paint job, a new roof, a fence, and/or landscaping
- Electrical or plumbing
- Windows, particularly for energy efficiency
- Increase Your Home’s Energy Efficiency. Another great way to create value for yourself and on the future resale of your home is by increasing its energy efficiency. Weatherizing your home increases its energy efficiency and can come from new double- or triple-pane windows and better insulation above or below the home or in exterior walls. New appliances can also increase your home’s efficiency over time, as can low-flow toilets. Added benefits of all of these include energy cost savings and less environmental impact.
- Add an Addition to Your Home. Another great way to use your home equity is to add square footage to your home. This might be realized by adding a bedroom or family room, or by increasing the size of your kitchen or bathroom. Thoughtful additions can provide additional value for you and for a future resale.
- Consolidate All Eligible Debts Into One Payment. Leveraging the equity in your home to consolidate debt can ease your mind by leaving you with one loan payment per month, as opposed to several. However, the same rules above apply here as for credit card debt consolidation — ensure that you aren't getting yourself into a deeper financial hole with longer terms and higher interest rates, and then falling back into the trap of taking on more additional debt again.
- Pay for Educational Expenses. Another way people may use their home equity is to pay for upcoming college expenses for a child or family member. Higher education can be expensive and utilizing your equity can possibly eliminate the need for student loans. If your home equity interest rate is lower than student loan rates, this option can save you money. It can also allow you to spread the payments out over a longer period of time, which can be particularly beneficial if you foresee a steady increase in income in the future.
- Plan an Amazing Vacation. Normally, vacation expenses are not a good use of debt. However, de-stressing with a great time away can energize and refresh you and even help spur some creative thinking. There can be times when an amazing adventure is not only nice to have, but perhaps necessary for physical and/or mental health, particularly if you have been working hard for long hours, whether as a volunteer or for pay, or if you have been isolated at home for a while. There definitely are circumstances under which many of us could use an amazing escape.
- Create an Emergency Fund. Good personal financial practices always include having an appropriate emergency fund on hand just in case. Some experts recommend having 6 months’ worth of expenses, others advise having enough of a cushion to last you a year. In 2020, the unemployment rate skyrocketed due to the coronavirus pandemic, and those fortunate enough to have a strong emergency fund may have been able to weather the tough economic climate. Most people, however, do not have the ability to weather dire financial situations, and a home equity loan can help you build a fund to cover such circumstances.
- Invest in Real Estate. Real estate investing can be a risky use of home equity. However, if you know what you’re doing, you can use the equity in your home to put that value to work for you by investing in additional real estate. If you think that this might be a favorable option for you, seek advice from real estate investment experts, do your research, and remember that all investments are not guaranteed to go up in value; if there is not a good chance that yours will, this option might not be worth the risk to you and your family.
- Handle Emergency Expenses. There are many reasons why you might suddenly need to dip into the equity of your home to pay for emergency expenses. Using home equity in a particular emergency is similar to using it to build an emergency fund, but instead of using it to create a cushion, you may need money immediately for medical expenses or other such emergencies.
It's important to remember that a home equity loan or line of credit is still a loan. As such, there are limits to what you can borrow, there may be costs to borrow the money, and of course there is interest incurred over time. Make sure that you understand the pros and cons of taking out a home equity loan, and as always, do your homework to determine if this is the best use of your financial equity.