5 Best Ways to Use a Home Equity Loan | Mortgages and Advice
As your home’s equity increases, you may be tempted to turn your capital gains into cash with an equity loan or cash refinance. According Black Knight, a provider of mortgage technology and data. But before tapping into the equity in your home, think about how best to use it.
A common and clever use of home equity is to improve the home. But can home equity also be a good source of funding to start a business, buy more real estate, or take a long-awaited vacation? Generally, the best use of home equity is to add value to your home or improve your financial situation.
Read on to learn about the best ways to use a home equity loan and when borrowing against your home could spell disaster.
What is a home equity loan?
A home equity loan allows you to borrow a lump sum against the equity in your home. The equity in your home is the difference between the amount you owe on your mortgage and the value of your home. With a home equity loan, you turn that equity into cash that you can use now rather than later when you sell your home.
You can access the equity in your home with a home equity loan, cash refinance, or home equity line of credit, also known as a HELOC. Whether you choose a home equity loan or a HELOC, you can usually borrow up to 85% of the equity in your home. The amount you can borrow with a cash refinance is capped at 80%.
Expect to pay around 2-5% of your loan amount in closing costs, on top of your interest rate.
Reasons to leverage your home equity
Home equity loans usually have low rates because they are secured by your property and they allow you to borrow large sums of money against your home. A home equity loan can give you a lot of buying power to achieve goals like starting a business, paying for college, or renovating your home.
This type of loan can be a good alternative to higher interest unsecured financing options, such as credit cards or personal loans. Just make sure you have a good plan for using the equity in your home.
“Loans or lines of equity are extensions of credit, so if you need the extension then of course use it,” says credit expert John Ulzheimer, formerly of FICO and Equifax. But don’t worry if you don’t need to take out new credit, he says.
What can a home equity loan be used for?
You can use a home equity loan for almost anything you want, but not all ideas are good. Here are some of the best ways to use the equity in your home:
1. Improve your home
One of the most common ways to use a home equity loan is to improve a home, says Dave Krichmar, a Houston mortgage banker. Recently, “the absurd increase in equity has encouraged many people to withdraw money to do things they might not otherwise be able to afford,” he says.
Home improvement projects can make your home more comfortable and increase its resale value, which can pay off when you sell. Understand that you’re not likely to see a 100% return on investment from any home improvement, however.
“As long as you can use the value of your home to further increase the value of your home, that makes perfect sense,” says Ulzheimer.
You can also deduct interest on your home loan, but only if you use it “to buy, build, or substantially improve” the home securing the loan, according to the IRS.
2. Debt consolidation
The equity in your home could help you pay off your high-interest debts, like credit cards and loans, at a lower rate over a longer term, which would lower your monthly bills and expense. total interest.
“The best-case scenario would be to use a cheaper equity loan to pay off more expensive debt,” Ulzheimer said.
Using home equity to erase credit card debt can make a big difference in your day-to-day financial life, Krichmar says. Maybe your credit card bills are daunting at $1,000 a month, but a home equity loan that pays them off and adds just $200 to your monthly mortgage payment is manageable.
One caveat when using the equity in your home to pay off debt is that you are turning unsecured debt into secured debt. Make sure you can make the payments and don’t go into debt because your home is at stake. debt consolidation, says Krichmar.
3. Start a business
If you’re sitting on a lot of equity in your home, you could turn it into a source of funding for a new business. A home equity loan probably has a lower rate than a business loan.
Using home equity to invest in real estate is popular, as some homeowners turn equity into a down payment — or outright purchase — for an investment property. Krichmar is a follower of this approach and has done it himself, cashing in the equity in his home to put it up for rent.
But remember that no business has a guaranteed return on investment. You could lose some or all of your money and still have to repay the loan. And if you fail to pay off your home equity loan, you could lose your home.
4. Pay for college
Higher education, whether for you or your children, can be a good investment for the future. Tuition fees can be prohibitive in some cases and families may not qualify for the financial assistance they need.
A home equity loan can be a good alternative to private student loans, especially if home equity loan interest rates are lower than student loans. If you choose a longer term for your home equity loan, you may get a lower monthly payment than a student loan.
Before tapping into your home equity, maximize any federal financial assistance available to you. If you’re paying for college with a home equity loan, you won’t get all the benefits of federal student loans. In recent years, borrowers have seen student loan relief and the potential for generalization federal student loan forgiveness looms.
Make sure the payments won’t slow down your retirement contributions or put your home at risk. A student loan may be a better idea because your child still has many years to earn income to pay it off.
5. Fund an emergency
If you don’t have an emergency fund to cover three to six months of living expenses, a HELOC could be your safety net while you save.
With an open line of credit, you have funds to cover unexpected home repairs or medical expenses. And as you pay off your HELOC, the line of credit will return to its full value. Just make sure you can pay off your HELOC before you borrow against your home for an emergency and work on building your savings.
How not to use a home equity loan
The worst place to put your home equity is for short-term uses, Krichmar says. This may include:
- Daily costs.
- Market investments.
- Loans to family members or friends.
The benefit should outweigh the cost, Krichmar says. If you’re taking out a small home equity loan, consider the fees carefully. If they are too high, they could cause the cost to exceed the value of taking money out of your home.