Alene Laney 
Home equity can be a powerful tool for improving your finances and building your wealth. However, there are some costly mistakes you can make, too. Here’s what you should know about what you can do with home equity in a strategic, smart way while avoiding common pitfalls.
Key Takeaways
- You can improve your financial situation using your home equity.
- You can build your credit, boost your savings, improve your home, create wealth, start a business, and make strategic investments with home equity.
- Be judicious with using your home’s equity, as there are some issues you’ll want to avoid, and you could face the risk of foreclosure should you be unable to repay the new loan.
- There are more options for accessing your home’s equity than you realize; be open and do your research to see if there’s one to fit your unique situation.
What Can You Do with Home Equity?
Home equity is one of the most powerful tools homeowners can use to access a large sum of money with low-cost financing. That can open doors to improve your life and finances by allowing you to pay down high-interest debt, invest in things you believe in, start a business, continue your education, and more.
However, the cost of home equity can be high. In this article, we’ll cover what you can do with equity in your home and what mistakes to avoid with home equity.
9 Smart Ways to Use Your Home Equity
Home equity loans are among the most common ways to tap home equity. Whether you take out a home equity line, a home equity line of credit or opt for a cash-out refinancing, accessing your home equity can open up a world of possibilities. Here are some of the ways you can use your home equity to improve your finances:.
Pay Off High-Interest Debt
High-interest debt is a financial killer. Every month, you’re paying money towards interest that doesn’t serve you. Paying it off doesn’t just give you a sense of relief – it’s a real financial boon. Using home equity can grant access to a significant amount of money to pay off all those bills and get you back to a manageable life.
Pros
- High-interest debt may be replaced with a low-interest loan.
- May have a more affordable loan payment.
- May have access to larger loan amounts to consolidate large amounts of debt.
Cons
- Consolidating debt may not help with the root cause.
- Many consumers will take on more debt on top of the consolidated loan.
- Your home is at risk if you’re unable to make the payment.
- Must qualify for the loan and make the monthly payment.
Fund Major Home Improvements
Home improvements that increase the value of your home could be a smart move. For HELOCs and home equity loans, the interest is tax-deductible (if you itemize) on home improvement costs taken on a home equity loan.
Pros
- Home improvements could increase the value of your home and make your home more comfortable and efficient.
- Flexible use of funds.
- May be a more affordable option for financing improvements than personal loans
- Potentially tax-deductible.
Cons
- Home equity is used to secure the loan, which puts your home at risk.
- Must qualify and make payments.
- Could reduce equity stake in home.
Invest in a Second Property
You can use home equity to fund a down payment, closing costs, improvements, and other costs on a second property. If you want to get started with real estate investing and build your wealth, leveraging your home equity can help you get started.
Pros
- More readily available cash for down payment, closing costs, renovation expenses, and more.
- May be able to negotiate better with cash offers.
- Opens the door for more financing options with a higher down payment.
Cons
- Need to manage multiple payments
- You need to qualify for financing.
- Your primary home is on the line if you fail to make payments.
Start or Expand a Small Business
Home equity can grant access to funds needed to start a business. Whether you need to buy supplies or hire employees, home equity may be able to provide funds to run the business.
Pros
- Flexible funding for any business expense.
- Larger loan amounts.
- Typically cheaper than financing through business loans or credit cards
- No investors to pay back.
Cons
- Requires good personal credit and sufficient income to repay the loan.
- Your home is at risk.
- Doesn’t build business credit.
Support Education Costs
If you or a dependent is in the process of getting an education, you’ll need a substantial amount of money to support that endeavor. Home equity offers a flexible way to take out a large amount of funds to support the cost of a professional education.
Pros
- Education expenses can be paid for with home equity.
- More flexible use of funds.
- Often better terms than student loans.
- Larger loan amounts.
Cons
- Need to make loan payments while in college (though arguably, this could also be a positive to some).
- Need to pay for costs associated with getting a home equity loan.
- Harder to qualify for than a student loan.
- Foreclosure risk if payments aren’t made.
Boost savings
Need to add to your savings or emergency fund? Using home equity to bolster your savings is possible. However, you are taking on debt with interest, so you will pay a significant amount of money to boost your savings.
Pros
- Larger financial cushion for planned life events or emergencies.
- More flexibility and peace of mind.
- Lower interest rate than other loan types.
- Can help with planning for future events.
Cons
- Monthly interest and loan payments can diminish the savings you’re trying to build.
- Your home is at risk if you fail to make payments.
- Closing costs can add up.
Cover healthcare costs
Home equity can be used to help cover costly healthcare expenses, such as the birth of a child, IVF, surgical procedures, and more.
Pros
- Healthcare bills won’t go to collections.
- You may be able to negotiate a cash discount.
- Lower interest rate than credit cards.
- You may lower your monthly payment by spreading the payment out over a longer period of time.
Cons
- You might see better installment payment options from the medical billing department.
- You convert unsecured debt to secured debt, which isn’t generally advisable.
- Your home is at risk if you fail to make payments.
Use a Home Equity Agreement (HEA) for Flexible Cash
A Home Equity Agreement (HEA) is another option for accessing home equity to potentially improve your financial situation. A home equity agreement exchanges a portion of your home’s future equity for cash now without monthly payments. Qualifications are more flexible, and repayment occurs at settlement in a balloon payment.
Pros
- No monthly payment.
- Easier credit and income qualification.
- Possibly faster funding.
Cons
- Repayment is required in a lump sum at the end of the contract.
- Total costs depend on the market appreciation of your home, and you won’t know an exact number until you request a settlement.
- Not available in every state.
What to Avoid When Using Your Home Equity
While home equity is a powerful tool, there are mistakes you may want to avoid when it comes to using it. If you don’t want to learn an expensive lesson, consider the following:
- Overleveraging your home: It is possible you can take too much equity out of your home. If the housing market takes a serious downturn, you could end up underwater or unable to sell.
- Using equity for depreciating assets (e.g. luxury cars): Use your judgement when it comes to tapping equity to pay for things that lose value. (Think boats, RVs, cars, vacations, etc.).
- Underestimating fees, rates, or tax implications: Home equity loans and HELOCs come with costs, including application fees, appraisals, and many more. There’s also a misunderstanding that home equity loans are tax deductible, when only the interest on certain purchases that improve the property can be deducted, and only if you itemize deductions.
- Ignoring loan repayment risks: Home equity products offer some of the most affordable financing out there. However, it’s crucial to consider how the repayment plan will affect your life, and whether it’s truly affordable. It’s also important to consider the risks of not being able to make payments, which include potentially going through the process of foreclosure.
- Going into more debt: Acquiring more debt on top of a large home equity loan is easy to do. If you don’t have a plan for paying off the home equity loan, or don’t address issues that led you into debt in the first place, you may be in a worse place than when you started.
- Not considering loan alternatives: There may be situations where you consider an alternative to a home equity loan, such as home equity agreements (HEAs) like those from Unlock. HEAs may be more flexible and don’t have monthly payments.
How to Choose the Right Equity Option for You
There are many ways to access your home equity, and the right one for you comes down to your individual situation. Some questions to help bring clarity may include:
- Does your credit qualify you for a home equity loan or cash-out refinance? If it doesn’t, you may need to wait until you qualify or consider more flexible financing such as a home equity agreement or a reverse mortgage.
- Does your house have enough equity? With lower equity amounts, you may want to consider a personal loan or other financing.
- Can you afford the monthly payment? If you don’t want to make monthly payments, consider whether an HEA might make more sense.
- Do you prefer structured monthly payments and traditional financing? A home equity loan or HELOC may be the best financing solution.
- Is overall cost your biggest concern? Compare the total financing costs over time among home equity loans, HELOCs, cash-out refinancing, personal loans, HEAs, reverse mortgages, and other financing. A loan calculator can help as it considers not just the interest rate, but the loan repayment term, which can be more costly than you’d expect.
Conclusion
Home equity creates possibilities for homeowners. Whether it’s financing home renovations, chasing dreams, or building wealth, leveraging your home equity could make your financial situation better. Be judicious with how you use funds from home equity and make a plan for your finances so you know you’re on the right path for years to come.
