Home values have increased considerably in recent years, giving homeowners the ability to tap into their home’s equity to make renovations, large purchases or otherwise improve their overall financial picture.
While this can be a good way to access cash quickly, it’s important to proceed with caution and speak with a lending professional before doing so. After all, you’re borrowing against the roof over your head.
Think about how you plan to use the money. The most common ways to spend home equity are for home improvements, debt consolidation, college costs, emergency expenses and long-term investments.
- Home improvements
Home improvement is one of the most common reasons homeowners take out home equity loans or HELOCs. Besides making a home more comfortable for you to enjoy, upgrades could raise the home’s value and draw more interest from prospective buyers when you sell it later on.
But if you plan to sell the house, be mindful of the types of home improvements you make, because not all improvements increase your home’s value. Some improvements that will give you the best return on your investment are kitchen and bathroom upgrades, garage door replacements, a new roof, or sprucing up your outdoor space with a patio.
And with a home equity loan or line of credit, you may be able to deduct the interest paid, so you may want to consult your tax advisor before starting any renovations.
- College costs
Some of us may have children starting college this Fall, and a home equity loan or line of credit can be a good way to fund a college education because the interest rate might be lower than that of a student loan.
However, it’s important to look at all the options for student loans, including the terms and interest rates, to truly determine the option that’s best for your personal situation.
- Debt consolidation
A HELOC or home equity loan can be used to consolidate high-interest debts to a lower interest rate. Homeowners sometimes use home equity to pay off other personal debts such as a car loan or a credit card.
But you should be careful not to run up the balances on your credit card again after paying them off. If you do opt to use a home equity loan or line of credit to consolidate debt, you should make sure to have a solid financial plan in place to ensure that you can keep with your daily expenses and your loan payments.
It’s important to remember that your home equity line of credit monthly payments during the draw period, while you are only making interest-only payments, will be significantly less than the payments due during the amortization period, when you’re paying principal AND interest. Calculate the total cost and then take a close look at your financial situation to be sure you can afford those future payments.
- Long term investments
Some homeowners use home equity to invest in the stock market or real estate, expecting the returns to exceed the cost of a home equity loan.
This has risks, though, because there are no guarantees the stock market will perform as well as expected. Similarly, if you use home equity to invest in real estate, you can’t be certain the investment property won’t lose its value or bring in the income needed to get a return on your investment.
If you have your heart set on an affordable vacation home for your family and need a down payment, for example, a home equity loan may work for you. But if you want to invest in something riskier and hope to make more money, it’s better to look at other options.
Things to consider
The value of your home can decline
Although home values have been increasing steadily over the last few years, there is no guarantee that the trend will continue. If you decide to take out a home equity loan or HELOC and the value of your home declines, it’s important to know that you could end up owing more on your mortgage than what your home is worth. This situation is sometimes referred to as being underwater on your mortgage.
There’s a limit to how much you can borrow
It’s important to remember that there is a limit to the amount you can borrow on a HELOC or home equity loan. To determine how much money you’re eligible for, lenders will calculate your LTV, or loan-to-value equity.
Lenders generally allow homeowners to borrow up to 80% of the equity they have in their home. That number can be different from person to person, though, and depends on your credit score, financial history and current income.
Know how not to use your home equity
Most lenders and financial advisers agree that the worst reason to tap home equity is for unnecessary personal expenses, such as an extravagant vacation or a new boat or over-the-top luxury vehicle.
When it comes to your home equity, don’t borrow more than you need, don’t overspend on a frivolous purchase.
The bottom line
Even if you use your home equity to add value to your home or to better your financial position it’s important to work with a trusted lender who will review the numbers with you to ensure you can continue paying your regular mortgage on top of a new home equity loan — and that you have a solid plan for improving your finances with home equity money.
If you have questions, just Ask Washington Trust! Contact one of our Trusted Advisors at (800)475-2265 or by email at firstname.lastname@example.org.