Home prices have been climbing for the past three years, leaving many homeowners with extra equity to tap. More than 1 in 5 households with mortgages are equity rich, with equity worth at least 50 percent of their home’s value, while the average homeowner has about 38 percent available. The question becomes “what should you do with that equity?”
The surge in home values has propelled more than a million homeowners to seek out home equity loans, which are growing in size as well as number. Most will opt for a revolving home equity line of credit (HELOC), an affordable source of credit with interest rates averaging around 5 percent.
What will they spend it on? Nearly half will use their equity to spruce up their homes—the safest investment, since improvements can boost a home’s value. Nearly one in 10 will buy a car with it—not such a great idea, considering cars depreciate quickly.
Your home equity is “a precious resource that shouldn't be squandered,” says personal finance author Liz Weston. There are smart ways to use it, and there are not-so-smart ways. If you’re thinking of cashing in, make sure you’re doing it for the right reasons.
1. Debt consolidation
Most of us have some high-interest debts we’d like to get rid of. Credit cards, auto loans and personal loans can rack up hundreds of dollars in interest each month. If you’ve got a plan to pay them off in the next few years, a home equity loan can help you do it faster.
When you use a home equity loan to consolidate, you’re trading unsecured debt with a high interest rate for secured debt with a much lower rate—but higher stakes. If you can’t make the payment, you risk losing your house. But as long as you’re motivated and stick to your debt repayment plan, consolidating your debts into one lower payment can free up your income so you can pay down the principal faster.
2. Home improvements
Maybe you’re thinking about selling your home in the not-too-distant future. Or maybe you’ve decided to settle in for a while and want to arrange things more to your liking. Either way, home improvements are the smartest and most popular use for a home equity loan.
The best home improvements add almost as much to your home’s value as you spent on them. While it might be tempting to go straight for the big kitchen or bathroom remodel, you’re more likely to recover your investment on basic maintenance such as new windows, roofing and insulation, which recoup more than 80 percent of their cost.
3. College costs
Parents who don’t want their children saddled with more than $37,000 in student loans—this year’s average—often use their home equity to pay for college.
With lower interest rates, fewer fees and higher maximum loan amounts, home equity loans offer an alluring alternative to federal parent PLUS loans. They’re also more tax-efficient*, allowing you to deduct up to $100,000 of your interest payments each year while federal loan deductions cap at $2,500.
4. Emergency expenses
Are you prepared for the unexpected? Financial planners recommend stashing away three or more months’ worth of expenses in case of an emergency. If you haven’t done it yet, you’re not alone. It takes the typical family two years to save up that much.
A home equity loan can cover you in the meantime. If you have the will power, Weston suggests getting prepared by opening a line of credit but using very little of it. “The key, though, is, again, not to squander that equity,” she says. “You want it there for you when you need it.”
If you have some home equity to spare, putting it to work can be a smart financial move—as long as you spend it wisely. Connect with an OCCU representative to evaluate if a HELOC is the right choice for you.
*Note: The above information is not intended as tax advice. Please consult your tax professional for tax information.