
Due to persistent inflation over the past few years, borrowing costs are at record levels. The average interest rate on credit cards assessed interest is 22.76%, according to the latest data from the Federal Reserve. This represents an increase of over 6% in the past four years.
That said, one bright spot if you’re a homeowner is that although home equity rates have risen, they remain much lower than rates for credit cards. Two popular ways to use your equity include home equity loans and home equity lines of credit (HELOCs). If you need to borrow money, here are seven popular reasons to use your home’s equity.
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- Using home equity to cover various expenses can often be cheaper than other forms of debt like credit cards and personal loans.
- When you borrow against your home to pay for home improvements, the interest on the loan might be tax deductible.
- You can tap your home’s equity for almost any legal reason, including emergency expenses, major purchases like weddings and retirement planning.
1. Home Renovations and Improvements
One of the most popular reasons to use home equity is to pay for home repairs. Home improvement projects can spruce up your living space and some renovations (kitchen and bathroom remodels, for example) may even increase your home’s value.
Plus, another pro is that if you itemize your taxes when you file, you could deduct the interest paid on a home equity loan or HELOC.
Pros
- Interest may be deductible up to a certain limit
- Often cheaper than other financing options
- Can increase your property’s value
Cons
- Could lose home if you default
- Reduces equity in your home
2. Consolidating Debt
If you’re struggling to pay off credit credit debt (or other high-interest debt), consider using your home equity to refinance. Paying off debt with a home equity loan or HELOC could save you thousands on interest since they often come with more favorable rates.
However, keep in mind that if you refinance to a longer-term, you could end up paying more interest over the life of the new loan.
Pros
- Securing a lower rate can save you thousands
- May lower your monthly payments
- One monthly payment
Cons
- Might pay more interest over a longer term
- Debt consolidation doesn’t fix bad spending habits
3. Emergency expenses
If you don’t have an emergency fund—or an unexpected expense would exhaust your savings—tapping your home’s equity is one solution. It’s likely a cheaper solution than using a credit card, unless you can qualify for one with a 0% APR promotion.
However, there are some drawbacks to consider. For example, depending on the lender, it can take up to three weeks to receive home equity loan funding. As a result, it might not be the best choice if you need funds immediately.
Pros
- Could be a viable option as a last resort
Cons
- Could take a while to receive funding
- Putting your home at risk
4. Covering Major Purchases
Taking out a home equity loan or HELOC could also help you pay for major life events, such as a wedding or a trip for a milestone birthday. However, you may want to think twice before you put your home on the line to cover an unnecessary expense.
Only pursue this route if you can comfortably afford to repay the loan. If you default on the loan, a lender can take your home.
Pros
- Less expensive than some unsecured options
- Can help you avoid high-interest credit cards
Cons
- Taking on more debt
- Risking your home for an unnecessary expense
5. Funding Education
Another reason to use your home’s equity is to cover your (or your children’s) education expenses. If you can secure a lower rate than a student loan, it could be a wise choice. Plus, it could make sense to use your home’s equity to fund your education if you’ve exhausted your federal student loan limits.
Before you take this route, explore all of your options (starting with federal loans). Unlike federal student loans, a home equity loans and private student loans don’t come with access to student loan forgiveness programs and income-driven repayment plans.
Pros
- Rates could be lower than private student loans
- Could help you cover any funding gaps after maxing out federal loans
Cons
- No grace period
- Could be more expensive than a student loan
- Risk of losing home if loan not repaid as promised
6. Retirement Planning
If you need help covering expenses during retirement, using your home equity could help. You could take out a home equity loan or HELOC to cover medical bills or everyday expenses.
However, using a home equity loan or HELOC might not be ideal if you’re on a limited fixed income. That’s because you may struggle to repay the debt.
If you’re looking to supplement your retirement income, consider a reverse mortgage. Unlike a traditional mortgage, the lender gives you a lump sum of money or pays you in installments. You then repay the lender the original amount, including interest, when you sell the home or pass away.
Before you take one out, though, make sure you understand the pros and cons of a reverse mortgage. While it can provide much-needed income, it can make it more difficult to pass down a home to your heirs. Plus, if you fall behind on paying your home insurance or property taxes, a lender can foreclose on your home.
Pros
- Securing a lower rate can save you thousands
- May lower your monthly payments
- One monthly payment
Cons
- Could be difficult to repay loan with limited income
- Potential to lose home if you default
7. Investing in Real Estate
You could also use your home’s equity to put a down payment on an investment property. Note that this only makes sense if the return you can get from your investment exceeds the borrowing costs on your loan.
Pros
- Could earn a higher return than the loan’s interest rate
- Possible extra income stream
Cons
- No guarantee that investment will pay off
- Putting home at risk
When to Use Your Home’s Equity
Borrowing against your home’s equity could be a smart financial move if you think the benefits outweigh the drawbacks. For example, while tapping your equity could be the cheapest option, you could lose your home if you don’t repay the loan. If you need help deciding whether it’s right for you, contact a financial advisor who can provide advice based on your complete financial picture
By Jerry Brown