Home equity loans are flexible, allowing you to use the funds for almost anything. While there are some disadvantages, many homeowners find this is an ideal way to tap into their home’s equity when they need cash. Learn more about the benefits and risks of home equity loans.
How Can You Use Your Home Equity Loan?
Typically, lenders don’t place restrictions on how you can use a home equity loan. Commonly, borrowers use home equity loans to make home improvements, start a business, consolidate credit card debt, or pay for their kids’ college education or wedding. You can use the proceeds of a home equity loan for just about anything, but many homeowners use the funds for the following purposes.
Home Improvements
Home improvements are one of the most common uses of a home equity loan. Home improvements can include simple enhancements such as redecorating or more substantial upgrades such as replacing a roof or building an addition. Improvements made to your home may also increase its market value, which can, in turn, boost your equity. And while federal law does not allow a tax deduction for interest paid for other types of uses of a home equity loan, you can take a deduction for using the funds for home improvements.
Pay off High-Interest Debt
High-interest debt, such as credit card balances, can take years to pay off. Continuing to pay interest rates of 14% to 18% can add up to substantial losses over time. But by paying off this debt with a home equity loan, you can reduce your interest rate to 3% to 7%, depending on the loan term. Home equity loans provide a lump sum payment. So if you have enough equity in your home, you may be able to pay off all high-interest debt at once. This strategy enables you to make predictable fixed-rate payments over a period of four to 30 years.
Down Payment for Another Home or Investment Property
Let’s say you find a sweetheart deal on a second home or investment property but don’t have the money to make the down payment or do not want to wipe out your savings account. If you have enough equity in your primary residence, consider taking out a home equity loan.
Start a Business
Business startup costs often prohibit entrepreneurs from realizing their dreams. Depending on the type of business you want to start, you may face paying for office space, equipment, inventory, and employee salaries. Licenses, accountant and attorney fees, and marketing and advertising costs drive expenses even higher. But if your home has enough equity, a home equity loan might provide enough funding to get your business up and running.
Pay for College
A home equity loan can provide an alternative to student loans when it comes to helping your children pay for college or private secondary education.
Medical Expenses and Other Emergency Costs
The average cost of hospitalization runs about $10,000 per day. Major surgery requiring a long hospital stay, or lengthy rehabilitation, can rack up serious debt, even if you have health insurance. When life’s emergencies happen, a home equity loan can help you cover the costs.
When Is Using a Home Equity Loan a Bad Idea?
A home equity loan is an ideal tool when you need cash for a justifiable expense. But since a home equity loan is secured by your house, it’s not a strategy you should use carelessly. For example, it may not be a good idea to take out a home equity loan to fund a lavish lifestyle that is beyond your means or to take an unnecessary luxury vacation. Some homeowners rack up too much credit card debt and turn to a home equity loan to pay it off. That’s a great strategy—if the borrower plans to better manage their credit card usage and spending habits. If they continue their spending behavior, they might put their home at risk of foreclosure. Many people rely on their automobiles for almost everything, from getting to and from work to shopping for life’s essentials. Rideshare drivers and salespeople depend on their cars for a living. If you’re short on cash when your vehicle falls apart, a home equity loan can provide a down payment for a new automobile or pay for a reliable used car. However, you’re using your home as collateral versus the car with an auto loan, putting your house at risk if you cannot make the payments. Also, the interest cost might be higher with an equity loan in the long term since the term would be much longer than a standard five-year auto loan.
Disadvantages of Home Equity Loans
Home equity loans give you the advantage to take cash out of your home for nearly any purpose. However, home equity loans also come with a few disadvantages, such as:
You add another monthly mortgage payment to your expenses.If you lose your income, you face the risk of losing your home to foreclosure.If the housing market plunges, the added debt of a home equity loan might put you underwater if you decide to sell your house.Home equity loans require paying closing costs.
Is a Home Equity Loan Right for You?
A home equity loan is a powerful financial tool if you use it for the right reasons. Taking out a home equity loan for home improvements can increase your home’s value and equity. You can also take cash from your home to pay college expenses, buy a car, or cover unexpected emergencies such as medical costs. However, obtaining a home equity loan is not an action to take lightly. Using funds from a home equity loan to fund an extravagant lifestyle or pay for a luxury vacation that you could not otherwise afford can be risky. Since a home equity loan is secured with your house, you run the risk of foreclosure if you fall on hard financial times.
