Real estate markets are recovering in many parts of the country. That means homeowners may be able to tap their home equity to tackle long anticipated projects, repay higher interest-rate debt or solve cash flow problems. If you own a home that has little or no debt against it, or interest rates are currently lower than they were when the original loan was put in place, a cash-out refinancing may be the right option. But if, like many Americans, you already have a super low interest rate loan in place, a great way to access the home equity without disturbing it is most likely a home equity line of credit (HELOC) or a home equity loan. If you are having trouble deciding between the two consider looking over LendingTree's home equity vs HELOC article.
Here are four good projects (and just for fun, one bad one!) for which you could use that home equity.
Home Remodeling and Renovation
The right home improvement project can make your home more comfortable and increase its value, and thus qualifies as a good use of home equity. The first question to ask is, will your project require a large chunk of money upfront, or will you need to make a series of payments over an extended period of time? A fixed home equity loan is a great choice for a large project requiring a sizable upfront investment, because you can secure all the money needed upfront and get a fixed interest rate and set repayment term. A home equity line of credit (HELOC) is a good choice for a series of smaller projects, or a single long-term construction project, as you can withdraw funds as needed. This can help cut costs as interest is only due on the total amount withdrawn.
Homeowners struggling with consumer debt may find solutions to high finance charges and the chore of tracking multiple payments by consolidating consumer debt with an equity loan. Interest rates for home equity loans and HELOCs are lower than those of unsecured debt like credit cards, and interest may be tax deductible (check with a tax advisor). A debt consolidation loan rolls multiple accounts into a loan with one monthly payment, which should be lower than the total of the individual bills.
As a nice little bonus, borrowers who consolidate successfully may increase their credit score because:
- Eliminating credit card balances improves their credit utilization ratio
- Adding home equity financing may improve their mix of credit
- Lowering payments may allow them to accelerate their payoff
A quick caveat, borrowers should understand the ins and outs, including risks involved in consolidating.
Equity loans can be used to finance high-cost purchases such as boats, RVs, motorcycles, appliances, furniture or vehicles, and may offer favorable terms when compared to other types of financing.
Many financial experts (like the personal finance writers at the Wall Street Journal ) don't really recommend using long-term financing like a mortgage to purchase something that may not outlive the loan. That can cost the borrower more in the long run, even if the rate is lower. One option? Taking the home equity loan if the after-tax rate is lower, but choosing a higher payment so the loan is retired in three to six years. This way, a borrower benefits from the lower rate, but matches the life of the loan to that of the purchase.
While government-backed student loans may carry the lowest interest rates, their terms may not match those of secured financing like home equity loans and HELOCs. In addition, government loan programs have limits and may not cover all costs. If considering a private student loan, compare it to home equity financing. The HELOC lends itself to funding college tuition because borrowers can draw funds as needed and only pay interest on the amounts paid out. If the education itself offers a good return on investment, home equity can be a smart way of funding it.
What NOT to Finance with Home Equity
People do use home equity for vacations, "retail therapy" and other non-essential spending because it's relatively cheap and the payments are low. The problem is that while Christmas is over on December 26, the monthly payment for that loan could be there for several Christmases. The designer shoes will be out of style long before they've been paid for, and the vacation long forgotten as the monthly payments go on and on. The problem with home equity financing for unnecessary items is that borrowers can get accustomed to spending more than they earn, and it uses up an important asset for no good reason.