Home-equity loans can help you get out of debt, pay for home improvements and other big expenses, and put you well into the black, financially speaking. Home-equity money is yours to use as you wish, but most home owners focus on multiple economic priorities.
Here are four ways to use a home-equity loan:
1. Consolidate many debts into one
Debt consolidation is by far the most common way home owners use home-equity loans. It can also be the riskiest.
If you’ve racked up credit card and other debts, home-equity loans can pay them all off, leaving you with one monthly bill that’s likely smaller than the others combined. The interest rate on the consolidated debt will probably be half what you were paying on just one credit card, because the loan is secured by your home. Also, you can deduct the interest, up to the legal limits allowed for home-equity loans, and you may be able to pay off your debt sooner.
Having a single monthly bill can also improve your cash flow, leaving you more disposable income to save or invest. Over time, the single monthly payment improves your credit profile, revealing to lenders that you are a less-risky borrower who isn’t overburdened by debt.
However, the need for a home-equity loan could indicate a credit habit that the loan might only exacerbate. Don’t just pay off your old debts; cut up all but one card for emergencies. Consider debt counseling to learn how to budget your income. Tell creditors to close your accounts, so that you can’t use them and so that your credit report doesn’t show unused credit that you can still tap.
If there’s a difference between what you were paying each month on all your debts and the home-equity loan’s payment, save the money. Learn to use cash where possible. Most importantly, do not take on additional debt while the home-equity loan is still outstanding.
2. Invest the home-equity loan in home improvement
Home improvement is almost as common as debt consolidation as a use for home-equity loans. With carefully planned and professionally completed work, home owners improve the value of the home by adding square footage, bringing it up to current building codes and upgrading to contemporary design and features.
Potential problems stem from the decisions you make about the improvements. The best improvements increase the fair market price of your house. Remodeled rooms — notably kitchens and bathrooms — add the most value. Additions are fine, too, as long as you don’t overimprove. Additions should blend in both with your home’s existing style and with the design of the homes in your neighborhood. Interior painting, carpeting and the like probably won’t add much value, but those cosmetic touches will improve the salability of your home.
Keep in mind, however, that lenders who know your home is on the market may not give you a home-equity loan without additional costs. And if you have an equity loan when you sell your home, you must gross enough from the sale to pay off both the first mortgage and any outstanding home-equity loans.
3. Invest home-equity loans in college
Using home-equity loans for education is another popular choice, given the skyrocketing costs of post-secondary education. Also, families with higher incomes may not qualify for grants and government-backed student loans.
Education can be a good investment. An educated son or daughter is more likely to become financially independent sooner and can start building their own wealth rather than draining yours.
Unfortunately, college bills may come at about the same time when you are near retirement and may want home-equity loans to offset your reduced income. Don’t overlook special educational loans, tax write-offs and scholarships to meet your children’s educational needs.
4. Buy disposable goods and services
No matter what you do with your home-equity money, you can deduct the interest. That’s a compelling reason to buy those big-ticket items you’ve always wanted: a new car, a boat, a recreational vehicle. Home-equity loans are also a boon if you get hit with medical bills or some other emergency.
Don’t forget, though: When your car is ready for a trade-in, the recreational vehicle is up on blocks, and you are healthy again, you may still have equity loan payments to make. Your home is on the line.
Broderick Perkins wrote this article.