With interest rates low (and perhaps on the rise), real estate valuations relatively high, and lenders about as friendly as one could expect, it’s a good time to consider tapping any home equity you have via a mortgage, loan, or line of credit.
But there are certain good and not-so-good uses of that money. Here’s when and why you should think about borrowing against your home equity—as well as when you shouldn’t.
The first and best reason many homeowners tap their home equity is to pay for home repairs, improvements, or updates. This reason makes sense, as not only are these projects often unavoidable, but, once completed, provide some semblance of a payback via more enjoyment from your home, and/or an increased value.
It’s also acceptable to use home equity on your primary residence a purchase a second home or other real estate, as it may be easier to borrow against your current place compared to getting a loan for a cabin or recreational property. According to the Weekly Credit Card Rate Report at Creditcards.com, the current average interest rate charged on credit card balances is 15.18%.
If you have any kind of debt outstanding that is being dinged at a rate in the double digits, you may be able to save a lot of money in interest by tapping your home equity to pay off those credit cards. Plus, the interest on the home equity debt may be tax-deductible, and your credit score may improve once the credit card account balances get down to zero. Just make sure you don’t rack up a bunch of new debt on those credit cards, unless it’s to pay for an emergency.
Speaking of which, last but not least on the list of “justifiable reasons to borrow against your home equity” is to pay for an emergency that you (or a loved one) is undergoing. That could be something as innocuous as unexpected car repair costs, or as serious as medical expenses that aren’t covered by health insurance or Medicare.
However, since the last thing you would want to be doing during dire circumstances such as these is applying for home equity loan or mortgage, you should open a home equity line of credit now, before the emergency strikes. Then you can draw from it whenever you want, and worry about paying it off after the crisis has passed.
You might be tempted to use that home equity line of credit to pay for a new or used car. But that is usually a mistake.
First, if you have good credit, the interest rate you pay for a car loan might be the same or less than what you would get charged to borrow against your home. And once you’ve tapped that home equity to pay for a car, you can’t use it until you pay it off.
But if you get a traditional car loan, you will still have the home equity to borrow against for some other purpose. The same reasoning applies to borrowing for college expenses. Yes, the interest rate on education loans might be a bit higher than what a mortgage, home equity loan, or home equity line of credit might cost. But it’s usually better to borrow via federal student loans first before drawing from your home equity.
Then turn to your home equity once those sources are exhausted and the only other method of financing the education expenses is by taking out private loans with higher interest rates. Finally, it’s not a good idea to finance expenditures with little potential tangible payback (such as clothes, trips, and toys) by using your home equity. An easy way to remember this rule is that if it’s fun to buy and/or do, it’s best to wait until you can pay for it with cash.